strategic solutions for business - pomonaeconomics-files.pomona.edu/.../clients/ebay.pdf · 2002....

Carnegie ConsultingStrategic Solutions for Business

Barriers and Prospects for Growth in the

Online Marketplace

Prepared for:

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______________________________________________________________________________Carnegie Consulting

425 N. College Avenue s Claremont, CA 91711-1-

Table of Contents

Executive Summary ...................................................................................................... 2

Company Overview ....................................................................................................... 2

Internal Rivalry .............................................................................................................. 4

Substitutes and Complements ..................................................................................... 4

Entry .............................................................................................................................. 6

Buyer and Supplier Power ............................................................................................ 7

Strengths, Weaknesses, Opportunities and Threats ................................................... 9

Financial Outlook ........................................................................................................ 11

Strategic Analysis ....................................................................................................... 16



Executive Summary

As the dominant player in the growing online retail marketplace, eBay is expected toproduce dynamic growth moving forward. The online retail marketplace industrycompetes with other retail establishments, both on and offline. Services such as auctionmanagement, online payments, and insurance help attract and retain buyers and sellers.Major entry barriers include first-to-scale network advantages and branding.Establishing a base of buyers and sellers and a reputation of quality and integrity arevital for success.

Strengths of eBay are its first-to-scale advantage, brand reputation and organizationalstructure. eBay is weak in the foreign markets where the firm has not been able to scalequickly. There are many opportunities for eBay, including new product categories, newtypes of sellers, expansion of storefronts, increased movement overseas and fixed-pricetrading. Threats include a change in consumer preferences or confidence, loss of thecollectibles niche market, increases in cyber theft, and the often-lengthy time lagbetween entrance and profitability in foreign markets

Carnegie Consulting’s analysis of boundaries to growth reveals that eBay should focuson attracting new storefront sellers and not expect high-volume sales from any of itscorporate suppliers. Increased costs from attracting and managing these sellers will notconstrain profitability because of increased sales from their presence – both from theirown sales and the site-traffic they generate. For the collectibles niche market, CarnegieConsulting foresees stability in the short-term as eBay focuses on storefront expansion.In the long-term, however, our firm recommends that eBay reinvest in its social capital(i.e., the sense of community generated by eBay users), the asset that helped the firmachieve its original success. As eBay moves forward and continues current growthstrategies, we advise the firm to establish a partnership with a major Internet searchengine.

Company Overview

In September 1995, founder Pierre Omidyar brought eBay to life in his small apartment.From those humble beginnings, eBay has transitioned itself quickly into today’s leadingonline marketplace for the sale of goods and services . The eBay community includes42.4 million registered users, and is the most popular retail site on the Internet whenmeasured by total user minutes.i

The eBay MissioneBay’s mission is to provide an easy-to-use medium to help practically anyone exchangeanything on Earth.

The eBay MarketeBay enables online exchange locally and internationally with a variety of internationalsites, specialty sites, categories and services. There were 126.5 million items listed onthe eBay site in Q4 2001.ii People come to eBay to buy and sell a wide variety ofpractical and one-of-a-kind items.



The Evolving Nature of eBayeBay is constantly changing as experimentation by millions of users on the site hasfueled organic growth. Over time, eBay has transitioned through several differentbusiness models. When the firm went public in 1998, eBay was a US-only auction-sitewith limited categories. Buyers and sellers were individuals, and goods listed weregenerally used, unique and hard-to-find. By 1999 and 2000, eBay experienced categoryexpansion and movement abroad to the UK. eBay also acquired Half.com and beganoffering basic services, such as insurance. Small businesses and governmentalagencies began buying and selling on the site. Today eBay has an internationalpresence in 19 countries, 18,000 categories, and an established fixed-price business(19% of revenue in Q4 2001 came from fixed-price sales).iii Buyers and sellers run thegamut, from individuals to billion-dollar corporations. Many types of goods are sold oneBay, including: automobiles, jewelry, musical instruments, cameras, computers,furniture, sporting goods, tickets, boats, and services.

Major Services and Features on eBay

Billpoint: Billpoint is eBay’s online bill payment service (jointly owned by Wells Fargo)that facilitates credit card payments between users.

Half.com: Half.com offers an online marketplace to buy and sell fixed-price, previouslyowned mass-market goods.

eBay International: eBay has country specific sites in Argentina, Austria, Australia,Belgium, Brazil, Canada, France, Germany, Ireland, Italy, Japan, Korea, Mexico,Netherlands, New Zealand, Singapore, Spain, Sweden, Switzerland, Taiwan and theUK.

eBay Motors: eBay Motors is the Internet’s largest auction-style marketplace for buyingand selling all things automotive-related. The site features a wide variety of vehicles,collector cars, motorcycles, and auto parts.

eBay Stores: eBay Stores allow sellers to create customized shopping destinationswith auction-style and fixed-price items.

Buy It Now: This option allows sellers to set a fixed-price for goods offered at auction.Once a bid is placed or the reserve price is met (depending on seller preference),however, the Buy It Now option disappears.

eBay Premier: A specialty site which showcases fine art, antiques, wines and rarecollectibles from auction houses and dealers. eBay purchased Butterfields, the 4th

largest traditional auction house, in 1998 to fuel this portion of the site.

eBay Live Auctions: Live auctions provides live, real-time online bidding for itemsbeing sold by the world’s leading auction houses.

eLance: A professional services marketplace within eBay. The subsite has over $75million in posted transactions and 300,000 freelancers ready to work on virtually anyweb-delivered project.



Internal Rivalry

eBay and its rivals are online retail marketplace providers that operate without inventory.The product of these firms is the connection they provide between buyers and sellers.Principal revenue streams come from charging sellers a listing commission and a final-value fee at the time of sale. eBay’s standard industrial classification number is 7389;the firm falls in the category of business services.

The retail industry currently transacts $1.7 trillion dollars in sales per year.iv According toProfessor Jim Likens, Senior Consultant to Carnegie Consulting, the online portion ofthese sales comprises only about 2 percent.v Growth potential in the online industry,therefore, is substantial. The major driving forces behind expansion are increasedglobal access to the Internet, an increasingly larger set of products available for sale andhigher utilization of the Internet by consumers in search of goods and services.

Online auction sites do not have geographic boundaries since the cost of informationdissemination over the Internet is minimal. The main obstacles to international growthare language and cultural barriers; for these reasons, marketplace providers oftenestablish specialized international sites, e.g. eBay Germany.

eBay’s major competitors are Amazon.com (auctions and zShops), Fairmarket AuctionNetwork (FAN), First Auction, Surplus Auction, uBid and Yahoo! Auctions. FANdeserves special notice due to its potential market position. The auction site is theagglomeration of a diverse array of companies including Microsoft’s MSN,Excite@Home, Dell Computer, ZD Net, Lycos and about 100 other companies. Whilethere are many different auctions sites available, eBay has the largest market share,approximately 88%.vi Auction sites compete on the basis of consumer base, communitycohesion, system reliability, website convenience, service fees and search tools.vii Inaddition, there is a subset of specialized auction sites that provide limited “niche”competition.

Although eBay is the dominant firm in the industry, auction sites like Yahoo! Auctionsand Amazon.com have additional revenue sources from businesses outside the industry.Although currently these other revenue streams are close to insignificant, these otherbusinesses could become more profitable in the future. A lack of dependence uponauctions as the primary revenue source could allow these companies to charge lessthan eBay and invest more in marketing and technological resources.

Substitutes and Complements

Substitutes

Other venues for buyers and sellers provide viable alternatives to online retailmarketplaces. The main substitutes to shopping through an online retail marketplaceprovider are (in order of potential risk to industry profitability): online retail sites, brick-and-mortar retail stores, direct mail catalogs, antique stores, garage sales, online andoffline classified ads, and offline auctions. The most relevant substitutes for eBay’sservices are rival online retail sites, such as Amazon’s retail site. These sites are



distinguished from marketplace providers by their centralized inventory systems (i.e.,these retailers hold their own inventory).viii The two industries can sometimes act ascomplements, with price differences resulting in higher volumes for the marketplaceprovider, as arbitrage occurs(assuming the marketplace has a lower cost). Thiscomplementary characteristic affects the top line, through volume increases, but alsoreinforces the constraints on seller’s pricing. These constraints hurt profit margins forthe overall sale, directly affecting the seller’s profits and indirectly affecting those of theprovider. Sellers are also attracted to online retail sites because of the reduced costsfrom having the retailer hold inventory. However, the online marketplace providerindustry currently focuses on sellers with low inventory costs, mainly person-to-persontrading, where online retail sites do not present a strong substitute for sellers.

Brick-and-mortar discount chain retail stores, such as Best Buy, also sell the samegoods as the online retail sites and so offer a similar challenge to profitability. However,these retail stores present a slightly different good because they have site specific, brick-and-mortar stores. These physical stores create an additional cost, and result in higherprices while attempting to make up for it by potentially providing in-person service.Buyers are less likely to compare prices between brick-and-mortar stores and sellers inonline marketplaces because of the higher information costs of obtaining regional storeprices while at a computer shopping at an online retail marketplace.

Antique stores and garage sales offer an alternative to both sellers and buyers,especially in the collectibles market. Despite this, neither presents a large substitutionrisk to the online providers because of their relatively small geographic scope and limitedproduct line. Many of the antique store owners and garage sale sellers have moved tothe online marketplace. Offline auctions present a similar picture, with many of theexisting auction houses being bought by companies within the online marketplaceprovider industry.

Classified ad providers, both online and offline, are marginally similar to online retailmarketplace providers, but they only provide a listing of goods, and their descriptions, topotential buyers. The substitution risk from classified ads is relatively small because oftheir limited information and lack of a developed model to link buyers and sellers in aliquid market for goods.

The transaction fees that online retail marketplace providers can charge are directlyrelated to the prices buyers in their marketplace are willing to pay. The higher the priceof goods sold in a marketplace, the more the provider can charge sellers for the service.This is because the profit a seller can achieve through listing their products determinesthe size of the pie that the marketplace provider and the seller can split. Alternativevenues for buying goods create downward price pressure and lower the profits earnedon each sale, shrinking the available pie of profits.

Complements

The main complements to the industry are online payment systems, auctionmanagement services (such as auctionwatch.com), and the computer and Internetindustries. Complementary companies present an opportunity for additional profits in theindustry as their growth funnels additional profits to online retail marketplace providers.



The main complementary benefits are seen in an expanding potential buyer and sellerbase and in decreasing the costs of each transaction for the sellers, increasing theirprofit before provider charges. Online payment systems, such as eBay Payment Serviceand PayPal, lower the transaction costs by offering buyers a more convenient andsecure way of purchasing goods. Since they currently charge sellers only a nominal fee,they have seen rapid growth that parallels the growth of online retail marketplaceproviders. Auction management services also allow users to reduce the transactioncosts of buying and selling. Escrow services, for example, reduce the risks ofconducting business in an online marketplace. This service increases the volume oftransactions in a marketplace by reducing the number of users who fail to purchase anitem because of the transaction costs relating to purchasing it. Additionally, decreasingthe costs of trade within the marketplace increases the potential profit to be shared fromeach transaction in the same way that a decrease in the cost of goods would normallyboost profits for a seller.

As the computer and online industries grow, the demand for online retail marketplaceswill increase. These complements provide an exceptional promise of growth in themarketplace provider industry, especially in countries that have just begun to embracecomputers and the Internet.

Bidding portal sites, such as biddersedge.com, allow users to bid on items from a varietyof online retail marketplaces and thus act as both complements and substitutes. Theyincrease the volume of transactions by reducing the searching costs. However, theyalso increase the price competition among the sellers, lowering the profits for sellers inthe marketplaces. An additional problem with bidding portal sites is that they limit thevalue of a specific provider’s brand by providing an equal number of buyers for a seller inany marketplace.

Entry

The online retail marketplace provider industry includes only one company withsubstantial market share, eBay. eBay has 42.4 million registered users and holdsapproximately 88% of the market.ix The ability of eBay to maintain such high marketshare will depend on its capacity to create and sustain entry barriers. In recent years,network externalities and brand loyalty have substantially limited the market share ofnew entrants and kept most potential new competitors out of the market entirely.

Network externalities are the most significant entry barrier. In brief, networking resultsfrom the creation of a large customer base of people all using the same site. Retailmarketplace providers attract sellers by offering them a large consumer base. For a newentrant to be successful, it must provide enough consumers for the sellers. Networkingexternalities make it difficult for new firms to accomplish this goal and create a circularbarrier (i.e., sellers will not be interested in a marketplace with few consumers, andconsumers will choose to patronize sites with a large number of sellers).

Branding contributes to a specialized consumer base and provides another disincentivefor companies to enter. A company creates two things by branding: First, a reputationfor providing certain goods or services, and second, an association with a certain level ofcustomer service and satisfaction. This leads to the specialization of the consumer



base. eBay is branded as the dominant online auction site as compared to a companylike Amazon that sells goods much like a normal retailer. Because of this differentiation,people desiring to purchase or sell goods through an auction will be attracted to eBay.For Amazon to attract such a consumer base would require a large investment in re-branding, which is expensive and not a risk-free proposition. The second part ofbranding leads to customer loyalty. If customers are satisfied with the value (benefitsless costs) they receive, an entering firm will have to provide an incentive to draw themaway. Normally this takes the form of a financial incentive, which reduces profits andhence the viability of entering.

Buyer and Supplier Power

Buyer Power

In the Internet retail marketplace “buyers” are the individuals, small businesses, andcorporations who sell goods. By its very nature the industry limits the power of buyers.A provider presents a buyer with a consumer market in which to sell its goods inexchange for a commission or fee. Since the on-line provider does not carry inventoryfor these sellers, it is precluded from the possibility of moving large volumes relative tomore traditional retail stores. However, on-line providers also avoid the risk of becomingdependent upon a few large volume sellers. Since marketplace providers are notdependent upon any single buyer, the loss of any subsequent business from anindividual seller will not substantially impact revenue. Despite this, large corporatesellers have power over eBay because their presence on the site attracts numerousvisitors. Unlike other sellers, eBay depends on these sellers for more than just the listingfees they generate – these sellers also increase site traffic and provide the reputationthat stands behind their brand name.

Due to entry barriers, the number of large online auction providers is limited. Given thisdominant position of several large players on the top of the market, sellers are not ableto search among a large number of providers for lower commissions or fees. Thisinability keeps sellers at a disadvantage. Unwilling to pay the commission or fee, aseller would be forced to attract customers on its own. If the cost of creating a newcustomer base is larger than the fees, the prospect is not attractive. An option thesellers do have is forward integration which would negate the commissions they pay andwould not require them to form a new customer base.

The threat of forward integration, although limited, provides some power to the largersellers in negotiating with the on-line provider. If a seller finds that a large portion oftheir business is done through a single marketplace provider making the cost of forwardintegration less than the commissions and fees, then the threat of forward integration ispresent. While this is a possibility, the purchasing firm would need the resources topurchase a provider – this is unlikely given the small individual size of the firms engagedin the market. Additionally, the purchase of an auction site would have to fit into a largerstrategic plan which is not appropriate for most retailers.



Supplier Power

There are two main categories of suppliers: purchasers and infrastructure providers.Purchasers are the companies or individuals who purchase goods from the onlinemarketplace site while an infrastructure supplier provides the necessary inputs tomaintain the site.

Individuals or firms that purchase large volumes tend to be excluded from the suppliercategory due to their ability to purchase directly from the retailer. The small number ofitems purchased marginalizes the impact of any lost business due to a dissatisfiedcustomer.

Even though the threat of individual dissatisfaction is small, the consequences of large-scale dissatisfaction are problematic. The movement of marketplace sites away fromunique collectibles to electronics and other mass-produced goods reduces the suppliers’dependence upon the site. In most cases, purchasers have the ability to purchase theexact or a substitute product directly from another retailer. If the convenience of the siteis counterbalanced by poor customer satisfaction, Internet retail marketplaces will nolonger be considered the more efficient method of shopping by consumers relative toother forms of retailing.

There are three major categories of infrastructure used by eBay. The key determinantsof supplier power are the competitiveness of the supplying industry and the nature of therelationship-specific investment. The more complex and dependent the relationship is,the greater the power of the supplier. Human resources, the first category ofinfrastructure, is a mix of investments. The majority of jobs at eBay can probably beperformed by a multitude of persons and so reduces the power of eBay employees toextract profits. On the other hand, positions where eBay has invested in large amountsof firm specific human capital are costlier to replace and so provide a better position tonegotiate.

Hardware (e.g., computers, servers, etc.) is the second category of infrastructure. Thereare a number of firms that can provide eBay with large-scale hardware and support;therefore, this supplying industry does not have significant power.

The third major category of infrastructure is the software that runs eBay’s online tradingplatform. IBM and BEA, the two main software providers in this industry, engage inintense competition. This competition for market share necessarily decreases thesesuppliers’ ability to extract profits. An example is eBay’s recent transition to IBM’sWebSphere application platform which IBM provided at zero cost in order to outbid BEA.



Strengths, Weaknesses, Opportunities and Threats

Strengths

eBay has many resources that allow it to stand apart from competitors. Although eBaywas not the first mover in the market, it was the first to scale. In an environment wherenetwork effects are the dominant factor for success, eBay’s established customer baseprovides significant flexibility and opportunity for growth. eBay has become thedominant marketplace not only in the US, but also in Germany, the UK, France,Australia, and Canada.

eBay has also been able to create a sense of community and trustworthiness thatattracts and retains buyers and sellers – this resource might be called eBay’s “socialcapital.” This community has acquired experience through message boards, chatrooms, and the personal contact between buyers and sellers. Review ratings keepbuyers/sellers in check and help prevent fraud. Many people have quit their jobs inorder to manage their eBay auctions – eBay has become a way of life for many stay-at-home moms. These “eBay-ers” often interact with one another and trade tips.

The eBay brand is a vital resource: eBay has become synonymous with online auctions.eBay’s social capital has also bolstered the brand to be more than just an Internetauction marketplace – eBay reflects quality and community. Effective brand competitioncould only come from a brand that has already been established in another market.

The organizational culture of eBay is also a company strength. Meg Whitman is not atypical new-economy executive; her experience comes from time spent as a Proctor &Gamble brand manager, a Bain consultant, and a Hasbro division manager. Thecompany is run with a corporate, rather than a dot-com, mentality. Old-school businessprinciples are applied in a casual atmosphere that produces content employees. AteBay, close attention is paid to data and auction categories are managed as individualproducts; the focus is on plans, systems, numbers and results. These efforts allow eBayto monitor customers and make adjustments accordingly. Promotional spots on the sitethat are not attracting hits are quickly changed. Keeping track of the number of visitorsto the site each week, items they looked at, and purchases they made, allows eBay toconstantly adjust the organization of the site in a way that maximizes revenues.

Since eBay has been profitable almost from the start, the firm was able to devote assetsto technology investment at an early-stage. With eBay already established, it has beenmore difficult for competitors to achieve profitability as quickly (if at all). eBay has alsoattracted about 30 large companies to sell on the site (e.g., Sears, IBM, Sun, Mitsubishi,Palm). The increased site traffic and advertising from these companies are majorstrengths for eBay.

Taken together, these competitive advantages have helped eBay make the transitionfrom a secondary collectibles marketplace to a general trading platform.



Weaknesses

eBay has little in the way of competitive weaknesses. Clearly eBay suffers to the extentthat not all consumers are willing to assume the risk of participating in its on-line market.And margins will always need to remain low. But these are industry-specific, not firm-specific issues. The major weakness facing eBay is the difficulty it will face whenentering markets where it does not already have a network advantage. In certain foreignmarkets, eBay is at a disadvantage relative to competitors (e.g. Yahoo! Auctionsdominates Japan and forced eBay out of the market earlier this year). eBay may alsoexperience difficulty competing with Fairmarket Auction Network (FAN), because largerfirms with more resources head FAN. Because many of the large corporations selling oneBay are part of FAN, it may be difficult for eBay to retain these companies if FANexperiences significant growth. eBay is also weak because the firm does not control anymeans of Internet access and, therefore, cannot automatically funnel new customers tothe site – eBay must rely on co-branding.

Opportunities

There are many opportunities for eBay: new product categories, new types of sellers,expansion of storefronts, increased movement overseas and fixed-price trading (see theStrategic Analysis section for further discussion of these growth opportunities). Recentauction category additions include real estate and human capital – if goods and serviceslike these can be successfully auctioned on eBay, the possibilities are nearly endless.The increased business from the global spread of Internet capitalism also providesopportunity for sales growth in new and as well as existing geographic markets.

eBay’s current position is a broad-focus, share strategy that provides a high benefit toconsumers. Because they value eBay’s large base of buyers and sellers, consumersare not very price sensitive. Nevertheless, sufficient viable competition does exist thateBay cannot raise prices significantly without losing customers and encouraging entry. IfeBay successfully continues to outperform its competitors, however, the firm may havethe opportunity in the future to raise fees and increase margins.

Threats

eBay’s ability to create value could be challenged by a change in purchaser tastes, or afall in consumer confidence of the eBay site and its sellers. If customer preferencesshifted towards off-line retailers or towards non-marketplace retail models, eBay wouldhave difficulty succeeding. An increase in cyber theft would also severely hinder eBay.The popularity of eBay could potentially fall as the novelty of the marketplace modelwears. Carnegie Consulting considers it unlikely that this will happen.

As eBay adds more big-name companies, the traditional sellers may become angry andswitch to alternatives. Brand-name firms are more likely to be featured in home-pagepromotions and given preferential treatment; they also, however, bring in more sitetraffic. Small sellers are likely to stay where the customers are – even though they may



become annoyed, seller-migration does not pose a significant threat (see furtherdiscussion in the Strategic Analysis section).

There is always the threat that eBay’s forays into overseas markets will not becomeprofitable. When considering foreign markets, it is more difficult to judge the buyingpatterns and changing attitudes of consumers. The time-lapse between acquisition andachieving profitability is risky. In geographic markets where network effects are high,possible success requires a significant capital outlay in order to buy the existing marketleader. Consider the recent acquisition of NeoCom Technology, the leading operator ofauction sites in Taiwan. The acquisition cost of $9.5 billion will reduce eBay’s second-quarter earnings-per-share estimate by a penny. NeoCom is not expected to add muchrevenue in 2002 and it is difficult to predict when profitability will be reached.xi

Financial Outlook

The equity markets have treated eBay’s stock positively in the past year (ending in March 2002),although most gains occurred early in the year. Chart 1, below, shows the stock’s partial recoveryfrom the technology sector’s valuation decline in 2000-2001. However, the chart’s value isminimal because company specific changes are often dominated by overall market trends.

Chart 1: eBay Stock Price History March 2001 – March 2002

Source: finance.yahoo.com



To further examine eBay’s stock performance Chart 2 shows the company’s stock price changesrelative to the NASDAQ index and to Amazon’s (AMZN) stock. Comparing eBay to similarcompanies allows one to see company specific trends, which are often dominated by market andindustry factors. Amazon is one of eBay’s biggest competitors, both inside the market and as asubstitute. Throughout the year eBay has outperformed the NASDAQ index, demonstratingsuperior investor confidence in eBay’s business model and its long-term survival. Only recentlyhas Amazon’s stock come back to match eBay’s stock price. eBay’s exaggeration of markettrends in the chart is largely related to its high volatility compared to the overall market, with acompany beta of 3.55.

Chart 2: eBay vs. Amazon vs. NASDAQ Stock Price History March 2001 – March 2002

Source: finance.yahoo.com



Revenue is shown on a quarterly basis in Chart 3. eBay continues to grow revenue at animpressive rate, both sequentially and year-to-year.

Chart 3: eBay Quarterly Revenue (MM) History September 2000 – December 2001

Source: wsrn.com



Despite the impressive revenue growth the company has been able to maintain strong operatingmargins as shown in Chart 4. The operating margins for eBay correspond fairly directly to itsprofit margins, but give a more direct picture of ongoing operations because they do not reflectinterest payments or taxes. The chart demonstrates the company’s ability to scale up, withexceptional revenue growth, while maintaining relative costs. There has been a moderate declinein several of their recent quarter-to-quarter operating margins, but year-to-year operating marginshave improved annually from 1999 to 2001. This increase has been fairly substantial, from a lowof 8.07 percent, in 1999, to the current 21.76 percent. Maintaining healthy operating margins isessential to eBay’s long-term strategy of net income growth through fast-paced top-line expansionwhile leveraging its existing assets, both real and intangible, to decrease the costs pertransaction.

Chart 4: eBay Quarterly Operating Margin (%) History September 2000 – December 2001

Source: wsrn.com



eBay had a relatively small amount of debt in 2001, with $12 million in long-term debt and $180.1million in current liabilities. The company has grown primarily by using its strong equity positionand it has remained an extremely liquid company, easily able to cover its short-term debtobligations with its current assets. Chart 5 shows the company’s current ratio, defined as currentassets divided by current liabilities. Over the past 6 years the company has maintained a strongasset to liability position and has strengthened the ratio even as it increased its debt position overthe years, from current liabilities of $910 thousand in 1996 to its previously mentioned $180.1million in 2001. Overall, eBay presents a strong balance sheet, causing minimal concern about itsability to meet short-term debt obligations.

Chart 5: eBay Current Ratio History 1996 – 2001

Source: wsrn.com



Strategic Analysis: Growth Barriers and Prospects

Summary

After examining eBay’s current market position and future prospects, CarnegieConsulting believes that eBay has the potential for substantial growth. The company’scurrent goal is to become the prevailing Internet retailer by establishing a global onlinetrading platform where anyone can trade almost anything. Although it remains unclearwhether eBay can attain this goal, especially on the international scene, constantmovement into new product categories, increased fixed-price trading, further penetrationof some foreign markets and more retail storefronts provide ample opportunity forexpansion. Category and geographic expansion will be the primary drivers of growth.Given that growth appears inevitable, Carnegie Consulting has chosen to focus ouranalysis on boundaries to growth. A two-part approach looks at (1) What boundaries togrowth might stand in the way of eBay’s expansion? and (2) Should eBay intentionallyset boundaries to its own growth in order to protect the niche market of one-of-a-kind-goods? We also make a recommendation for the next step in eBay growth strategy.

Preliminary Analysis

We begin our analysis with a comparison of retail models with centralized anddecentralized inventory. We consider retailers that hold inventory (e.g., Amazon, brick-and-mortar stores) to be centralized, and retailers without inventory to be decentralized.Centralized-inventory retailers incur additional costs associated with being the principalin their sales: warehouses, inventory management, risks associated with misjudgingdemand (i.e., excess inventory), collecting payment for goods, and shipping.Decentralized retailers avoid these costs; however, they are unable to guaranteesupplies of specific goods for their customers. Centralized retailers are able to takeadvantage of economies of scale and scope associated with storing, managing, anddistributing inventory. This is capsulated in Chart 6.

Chart 6: A Comparison of eBay and Amazon

eBay AmazonInventory* $0 $174,563

Fixed Assets* $125,161 $366,416

Total Assets* $1,182,403 $2,135,169

Total Assets dedicated to

inventory and fixed assets 10.50% 25.30%

*Figures in Thousands

Source: Amazon,com, Inc. and eBay, Inc., 2001 Form 10-K filings.

Inventory and Fixed Assets as a Percentage

of Total Corporate Assets



Centralized-inventory retail models have been historically dominant. Old-fashioned“Mom and Pop” stores exhibited a high-degree of centralization; storeowners purchasedtheir inventories from wholesalers, stored them in their shops, and resold them tocustomers. Chain retailers internalized the wholesale inventory function and boughtdirectly from manufacturers. The popularity of Internet retail marketplaces, however, maybe indicative of a trend moving towards less centralization. Consider grocery stores asan example; many suppliers now deliver, shelve, and manage the inventory of theirproducts. The suppliers, not the retailer, assume some of the risk of holding inventoryand predicting demand.

There has clearly been a trend toward consolidation of many retail markets. Introductionof technology to manage the inventory supply chain has increased annual sales persquare foot. Inventories are turning into sales at a faster rate than anytime in the past.All this has greatly increased profitability. Consolidation has also increased retail power,which has allowed retailers to shift costs to their suppliers. With suppliers assumingmore of the cost burden, some large retailers have been able to extract a larger share ofthe profit from final sales.

eBay’s success can be viewed as an extreme version of these trends. Inventory as apercent of sales in retailing is falling. Is a retail marketplace model like eBay the logicalend to the trend? In the limit, the ratio of inventories to sales approaches zero (as ateBay). The decentralized inventory (held by eBay’s customers) appears literally at thelast minute, at the time of sale when buyers and sellers are brought together. Noinventory is held at eBay.

Is the eBay online model the ultimate end of these trends? Will it take over all of onlineretailing? Or is this not even the equilibrium model for eBay?

Carnegie Consulting believes that there will not be a single type of online retail modelthat operates without retailer inventories – there is room in the market for severalvariations. Consider the traditional, brick-and-mortar retail market. Consumerspurchase goods from a variety of retailers, sometimes located near one another andsometimes far enough apart to require travel. Even with the costs incurred by travelingfrom store to store, consumers frequently choose to comparison shop and oftenpatronize several businesses in the same retail segment. Likewise, in the online market,where costs of comparison-shopping are very low, it is improbable that a single retailerwill ever prevail. Both centralized and decentralized-inventory retailers will continue tothrive in the online space. eBay (including Half.com) is already the #1 Internet retailer,but becoming the Internet retailer is unlikely.

A decentralized inventory structure is the appropriate equilibrium for eBay. The structureof eBay is more like a telephone company or a fully automated stock exchange than atraditional retailer; the eBay marketplace is a system that facilitates the interaction ofbuyers and sellers. None of these companies produces anything except a means toconnect one set of transactors with another. The core competencies of eBay are theskills necessary to provide such a marketplace: community development, branding, siteorganization and layout. By housing inventory, eBay would discard its gold minebusiness model and need to gain a completely new set of skills.



Expansion Boundaries

The primary factor we examine to determine where eBay might establish boundaries togrowth involves its suppliers. Over time the power of eBay’s suppliers vis a vis itsbuyers has increased as the supplier type it serves has changed. The original suppliersof goods on eBay were households and small-business owners – now corporations suchas IBM, Home Depot, and The Sharper Image supply increasingly more goods. Asaverage supplier size increases, will eBay lose some of its retailer power? eBay’scurrent strategy involves increasing the number of large corporate suppliers. Is it likelythat efforts to increase sales through larger suppliers will backfire by eroding eBay’scurrent power advantage?

Our findings lead us to believe that potential power losses from larger corporatesuppliers should not be a major concern for eBay. In order for these suppliers to gainpower, their sales on eBay must be high-volume. As long as eBay storefront salesoperate as small inventories of excess or out-of-date merchandise, eBay need not worryabout making concessions in order to retain suppliers. On the other hand, eBay cannotexpect to boost sales through substantial increased volume of individual storefrontsellers – increased sales-volume can only come from the addition of more storefrontsuppliers. Large firms will not be willing to sell high-volume on eBay. These companiesare designed precisely to interface with centralized retail inventory systems. Thebenefits of selling on eBay are high for the type of items currently sold in on-linestorefronts, but they are significantly weaker for standard inventory. eBay’s dynamicpricing system allows sellers to avoid putting a price on difficult-to-price goods. Theseminimal benefits are not likely to outweigh the additional costs of managing auctions andshipping goods individually to buyers.

Another boundary to growth affecting profitability could potentially arise from the shiftingsupplier base. We have anecdotal evidence that more important sellers receive morebenefits. A “powerseller” who contributed $1,000 a month to eBay revenues was able toget a deadbeat buyer kicked-off the site despite the company’s policy of neutrality.xii If arelatively small seller can obtain this preferential treatment, imagine the potentialconcessions that may be given to billion-dollar corporations. Sellers that require moreattention and concessions will be more costly to eBay. Thus, the supplier trend fromhouseholds to corporations has a parallel trend of increasing costs for eBay. As eBaymoves forward, we recommend eschewing preferential treatment of large sellers – eBaybuilt its success on a platform of neutrality, and it should stray from this policy as little aspossible. We recognize, however, that special treatment for storefront suppliers may attimes be necessary and in eBay’s best interest (see following section for suggestions onhow to give preferential treatment without alienating small sellers). In general, however,increased costs from attracting and maintaining corporate suppliers will be offset by theincreased site traffic generated.

Niche Protection

As eBay experiences growth, it is important to keep its most important resource in mind– the company’s social capital. Aside from eBay’s first-to-scale advantage, the firm hasbeen able to get where it is today because of its credibility and sense of community. Thepower of eBay’s social capital explains why the company was able to almost double



profits in 2001 in the midst of a wounded economy and collapsing dot-coms.xiii Althoughgrowth based on relationships with large businesses may bolster profits in the near-term,it may deplete eBay’s essential social capital. The bond between eBay and thecompany’s original, core customers is necessary for future success. Customeracquisition, driven primarily by word of mouth, is dependent on maintaining a successfulcommunity of individual sellers. Given eBay’s dependence on social capital (at least upuntil this point), how will growth affect relationships with niche (i.e., one-of-a-kind,collectible) buyers and sellers?

As corporate suppliers become more common on eBay, it is inevitable that the old senseof community will deteriorate and erode the firm’s social capital. Although this sense ofcommunity was vital in the initial stages of eBay’s growth, the network effect nowprevails. Sellers may grumble about increased storefront sales, but the customer basewill prevent them from leaving in the short-run. Even though the individual sellers maybe negatively affected by a loss of community, they will be positively affected by theincreased site traffic generated by corporate suppliers.

As the number of storefront sellers on the site increases, we recommend that eBayincrease public relations with the individual sellers. In doing so, it should reinforce thesense of community that got eBay going in the first place. eBay must communicate theimage of big and small sellers being the same. The firm must emphasize and practicethe concept of the level playing field wherever possible, but also understand that brand-name suppliers may make it slightly more level in some places. We recommend thateBay maintain the policy of listing corporate and individual auction listings side-by-side inthe category sections [i.e., when a search for ‘IBM computer’ is performed, both types ofauctions should be displayed]. When eBay must make concessions to storefront sellers,we advise that they be behind-the-scenes agreements (i.e., private pricing policies).Other appropriate uses of preferential treatment are sales representatives andpersonalized service for customers such as IBM and Sun Microsystems. In the past,eBay marketing was conducted by word of mouth. In dealing with corporate clients,however, more traditional strategies are needed.

Even though niche suppliers and buyers will remain loyal in the near-term, the long-termprospects are difficult to foresee. We advise that eBay focus on growing the number ofstorefront suppliers, but keep an eye out for niche supplier migration. If members of theantique/collectibles markets become sufficiently disgruntled, new alternatives may arisethat would pose a threat to eBay. The firm must watch for these alternatives and beprepared to take steps to recoup buyers and sellers (e.g.,buy out alternative sites,engage in price competition, reestablish connections with one-of-a-kind markets). In anyevent, we recommend that eBay’s long-term strategy be one of reinvestment in andmaintenance of social capital. One way to do this would be to introduce acollectibles/antiques subsite. The one-of-a-kind market is differentiated from the rest ofeBay (especially after substantial growth in storefronts) and, therefore, it makes sense togive it individualized attention. With one-of-a-kind goods, issues of trust and authenticityare particularly significant and elusive. The network effects among these buyers andsellers, as well as the potential for community, are also much greater as a subset ofeBay because the participants in this market have similar tastes and interests.



The Next Step

A key to eBay’s growth going forward will be the ability to attract more visitors to the site.Carnegie Consulting advises that eBay work towards aligning itself with an Internetsearch engine – these options seem the most promising and to best fit the eBay profile.Rather than create a new search engine of its own, we recommend that eBay use itsfinancial position to create a partnership with one of the major search engines. Oncethis partnership has been formed, eBay and the search engine can launch a new,combination site. For the month of February 2002, eBay was the 9th most visitedwebsite. For many web-surfers, eBay is the second site they visit after their searchengine homepage. By pairing eBay with a browser, it can become the first site thatpeople visit. Further analysis should be performed to identify which major search enginewould produce the most positive synergies.

Chart 7: Ranking of Most Visited Websites (February, 2002)

1. AOL Time Warner2. Yahoo!3. MSN4. Microsoft5. Lycos Network6. About-Primedia7. Amazon8. Google9. eBaySource: www.Nielsen-netratings.com

Once the combination eBay/Internet browser site is in place, Carnegie Consultingrecommends that eBay use “cookies” to monitor the web-surfing habits of users.Promotions can then be specialized to users’ interests according to the websites theyvisit on a regular basis.

Conclusions

Our analysis of boundaries to growth suggests that eBay should focus on attracting newstorefront sellers and not count on high-volume sales from any of its corporate suppliers.Higher costs from attracting and managing these store-front suppliers will not constrainprofitability because of the increased sales the presence of these suppliers will bring –both from their own sales and from the site-traffic they generate. With regard to eBay’sniche market, we foresee stability in the short-term as eBay focuses on storefrontexpansion. In the long-term, however, we recommend that eBay reinvest in the socialcapital that helped the firm achieve its original success. As eBay moves forward andcontinues current growth strategies, we advise the firm establish a partnership with amajor Internet search engine.



i eBay Company Overview, www.eBay.com.ii Speech by CFO Rajiv Dutja at The Robertson Stephens Technology Conference, February 26, 2002.iii Ibid.iv eBay. eBay Annual Report 2000. San Jose: eBay, 2000.v Carnegie Consulting Partner Meeting, April 1, 2001.vi Ibid.vii Ibid.viii Discussed in more detail in the issue section of this paper.ix Standard & Poor’s. eBay. New York: Standard & Poor’s, 2001.

x Cox, Beth. “IBM Scores a Coup with eBay Deal.” InternetNews.com on the Web 6 September 2001. 30March 2002 <http://www.Internetnews.com/ec-news/article/0,,4_879361,00.html>

xi Kary, Tiffany. “eBay Exits Japan, Moves into Taiwan.” CNet, February 26, 2002, www.news.com.xii Schonefeld, Erick. “eBay’s Secret Ingredient.” Business 2.0. March, 2002.xiii Ibid.

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