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June 7, 1999

Egghead's Net Bet Pays Dividends

Move to Internet-only operation lets vendor cut inventory costs, boost sales

By Candee Wilde

Related links:

E-Commerce: New Sense of Urgency; Companies rush for online market share

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wo years ago, Egghead Inc. closed its chain of more than 160 software retail stores and staked its future on electronic commerce. At the time, this was a revolutionary attempt at business transformation. Today, the question is whether the Internet will sustain Egghead.com Inc. and fuel its growth.

So far, the results are impressive. Egghead.com has grown into a leading Internet discount retailer of computers, software, accessories, and peripheral devices--a major shift away from the software-only strategy the company pursued as a national chain. Egghead.com sells computer supplies, office products, consumer electronics, sporting goods, and jewelry.

The software-only strategy fell apart because most computers were being sold preloaded with software. Profit margins were shrinking in the software-only market. Since the changeover to the Internet, Egghead's inventory costs have dropped from about $100 million for its stores to $14 million as a Web business.

In addition to bringing inventory costs down, Egghead's move to the Internet brought the company savings from not having to maintain retail outlets and freed the company from needing to have display space for products.

Egghead.com chairman and CEO George Orban says senior management and the board of directors decided to close the retail stores largely to take advantage of the "substantial looming opportunity on the Internet." Closing the business entirely would have brought little return to shareholders, and Orban's team was determined to make use of the company's potential.

"Egghead had a very strong brand name, great vendor relationships, and a retail culture that would help us take advantage of the Internet opportunity," Orban says. "We had the financial resources to fund the transition, and we put together a management group that was up to the challenge of exiting the traditional business and entering the new business."

Freed from the restrictions of physical stores, Egghead has a merchandising team that continually evaluates new product categories it can add to its Internet venues. The company currently has an auction site, the SurplusDirect outlet store, and superstores Egghead Computer and Egghead Software.

Egghead.com says it receives about 7 million customer visits per month and has 40,000 products for sale. (A typical Egghead retail store used to carry about 2,000 products.)

The transition to Egghead.com took time and entailed liquidating a business that had been in operation since 1984, while simultaneously building an Internet presence. "The Egghead.com transition was so revolutionary it will go down as one of the most studied and watched business transformations," says Tim Klein, a research analyst with USBancorp Piper Jaffray. "Everyone is watching to see what happens and if it will work."

The company's success can be measured on several fronts. According to Media Metrix Inc., an Internet audience measurement company, Egghead.com had the eighth-highest number of new visitors among the sites it studied in January.

By late March, several major brokerage firms, including Pacific Crest Securities, Prudential Securities, and USBancorp Piper Jaffray, had initiated coverage of the online retailer's stock, all issuing "buy" or "strong buy" recommendations with their analysis. One reason for their interest was the huge potential market for Egghead.com and its competitors, which include Dell Computer and Compaq, to sell computer-related products on the Internet. Of the $150 billion worth of computers and peripherals sold in 1998, only 15% of those sales were made online.