August 7, 2000

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Long Arm Of The Law

By Beth Bacheldor and Steve Konicki

More on online retail:

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FTC Commission Actions

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ederal Trade Commission fines totaling $1.5 million are a wake-up call to online businesses: They better have infrastructures in place to handle orders and notify customers of problems or delays. If they don't, the penalties can be serious.

On July 26, the FTC charged seven companies with violating the longstanding Mail and Telephone Order Rule during the 1999 holiday shopping season. It said the companies broke promises of shipment dates and failed to alert customers of the problems-transgressions that couldn't go unpunished. "If you're in business-to-consumer E-tailing, you have the same obligations to conform to consumer-protection laws as a brick-and-mortar catalog operation," says FTC commissioner Mozelle Thompson.

But the agency's actions also raise a question: Should the government regulate E-commerce in this way, or should online retailers and other E-businesses be left to police themselves? After all, consumers now have greater choice and more power than ever before.

"I'm still a little bitter about the FTC thing, especially when we delivered on 99% of our holiday orders before Christmas," says Michael Wagner, senior VP and chief operating officer at KBkids.com, which was hit with a $300,000 fine.

The IT industry has a long history of self-regulation. But with the privacy debate still raging, online fraud, and the emergence of online marketplaces led by industry consortia (see story), some see the need for active federal regulators. "In a sense, the greatest part about the Internet is that it's self-regulated," says Sunil Mehrotra, founder and chairman of GetPlugged.com, a leading consumer electronics site. "But whether the social price is too high for that, I'm not sure."

Most online retailers agree that in the end, the issue isn't about FTC fines-it's about keeping customers happy. "This has nothing to do with the FTC," Wagner says. "If you want to be in business, you have to satisfy the customer."

For CDNow.com Inc., one of the penalized companies, the FTC's edict was a lesson it was willing to accept. "I think the FTC and CDNow have common goals-to ensure customer satisfaction," says Amy Belew, VP of customer service and operations at the online music store.

Web businesses have a powerful nonregulatory incentive. Forrester Research expects the number of online holiday shoppers to double this year, and predicts online consumers will spend $38.8 billion in 2000.

KBkids.com, a division of Consolidated Stores Corp. in Columbus, Ohio, which operates more than 1,300 KB Toys stores nationwide, isn't making excuses for the mistake that led to its fine. In the holiday rush, the E-retailer failed to remove from its site a standard message that said all orders would be shipped within 48 hours. That statement conflicted with a message telling shoppers that if they ordered by Dec. 18 they were guaranteed delivery by Christmas.

Under federal law, mail order and Internet merchants must deliver items by the time they say or within 30 days of the order if no delivery time is stated. If they can't, they must notify customers and give them a chance to cancel their orders for a full refund.

KBkids.com won't make the same mistake again, Wagner says. It plans to post a notice about holiday deliveries shortly before Thanksgiving, superceding its standard two-day delivery policy. And it's spending about $7 million to upgrade its infrastructure.

Dave Morrison, the chief operating officer at Patriot Computer Corp., thought his company would coast through last holiday season. But the Markham, Ontario, maker of Barbie and HotWheels PCs hit a snag that resulted in a $200,000 fine because it didn't properly notify customers about delayed delivery of the computers.

Morrison says his company was caught "by a snowball effect." First, it had to stop production when it discovered that a Chinese supplier's power supplies malfunctioned. When news leaked out that production had stopped on the much-sought-after computers, customers began calling in overwhelming numbers, he says.

The company's call volume increased sixfold. "Our phone system simply froze up," Morrison says. At the same time, there was a glitch in the homegrown software used to track customer records and automatically generate late-delivery notices. By the time Christmas rolled around, at least 1,000 customers hadn't received their computers or the required late-shipment notices, and many complained to the FTC. The law states that fines against Patriot could have totaled $11,000 per incident-or $11 million.

Patriot ended up paying $200,000. FTC attorney Heather Hippsley says the agency took into consideration the fact that Patriot had made provisions to manufacture and deliver the systems for which it was taking orders. But the company's failure to notify customers when it halted production prompted the fine. "For a lot of their customers, the HotWheels or Barbie computer under the tree was the biggest gift the family had bought their child," Hippsley says, "and it wasn't there." Morrison doesn't take issue with the FTC rules or with the fine itself. "It's natural that the government will try to regulate the industry," he says.

Toysrus.com Inc., plagued by late deliveries last holiday season, was fined $350,000 by the FTC. The online toy store is investing in a new IT and distribution infrastructure designed to get it ready for this year's holiday shopping season. The Woodcliff Lake, N.J., company tripled the size of its Memphis, Tenn., fulfillment operation to 1.9 million square feet by opening new distribution centers in Mira Loma, Calif., and Chambersburg, Pa. It also opened new administrative offices in New Jersey and the San Francisco Bay area.

Toysrus.com officials wouldn't comment on the FTC fine or whether the changes in the company's management, fulfillment, and IT structures were prompted by the FTC action.

The online retailers have since upgraded their systems (see story, p. 30), and the FTC will be checking to make sure they're in compliance. For example, CDNow.com must provide the FTC with samples, such as E-mail notices and screen shots of changes it's made.

Meanwhile, the FTC continues to watch other online businesses for further problems. E-commerce companies "need to realize that the cop on the beat is looking in their direction," says Peter Ward, a partner in the Nash-ville office of law firm Baker Donel-son who specializes in E-commerce.

Several of the retailers say the FTC initially discussed higher fines-close to $1 million. But the FTC negotiated lower penalties in exchange for assurances that the businesses would fix their problems, which in some cases necessitated system upgrades.

KBkids.com tried to do the right thing in the first place. It spent more than $1 million upgrading to second-day deliveries and flying employees to warehouses to help ship products in time for Christmas. The FTC considered those extra efforts during its negotiations. KBkids.com agreed to the $350,000 fine to "get this behind us," Wagner says. Had agreement on any of the consent orders not been reached, the FTC could have sued the companies in question or asked the Department of Justice to file charges.

The FTC's interest in online retailers' actions was piqued shortly after the 1998 holiday season, when it became aware that some E-retailers had problems meeting delivery requirements. At that time, the FTC issued guidelines for online businesses. But the large number of complaints about last year's holiday season and news coverage about them prompted the agency to look again, attorney Hippsley says.

After the 1999 shopping season, the FTC investigated 24 E-retailers, based on consumer complaints. The agency focused on the seven that were fined because it found serious violations. The other 17 either provided proper notification for late shipments or failed to do so in only a small number of cases, says Hippsley. Ward says the FTC likely reacted to complaints it received early in the year. "There could easily be more in the pipeline," he says. The FTC won't comment on ongoing investigations.

Several E-retailers say the FTC's actions could benefit E-commerce by raising the bar on customer service and educating consumers about their rights. Plus, it creates a more-level playing field: Those fined may have beat their competition by guaranteeing fast ship dates. "Not delivering stock as promised is the biggest insult you can slap on a customer," says Kal Raman, chief operating officer at Drugstore.com Inc. "Raising the bar is good for everybody. Plus, the fact that the FTC paid attention legitimizes the E-commerce channel."

Others disagree. Carlos Tribino, a founder and president of Bikeshop.com in Stamford, Conn., opposes the FTC's actions and government intervention in Web commerce. "It's not the government's role to tell us how to treat our customers," he says. "Consumers will tell online retailers what they want through repeat buying or not returning to a site. The market will regulate itself." Bikeshop.com sends an E-mail notice to customers if it can't deliver a bike within its posted four-to-seven day interval. "We do so because we value our customers, not because the government is telling us we have to," Tribino says. "E-tailers that don't satisfy customer demands won't last long."

Experts say the FTC's online actions are hardly unprecedented. The FTC issues settlements against catalog companies, too, Ward says. For example, Cyrk Inc., a Beanie Babies marketing organization, agreed on Feb. 17 to pay a $216,000 fine for failing to deliver its "Clubby" Beanie Baby within four to six weeks of Clubby's "birth date" in July 1998, as promised. When the company was unable to ship as promised, it didn't inform customers so they could accept the delay or cancel their orders.

The FTC has also been known to hit technology vendors hard. Dell Computer and Iomega Corp. each were charged by the FTC with violations of mail-order provisions and agreed to pay fines of $800,000 and $900,000, respectively. In Dell's case, the FTC claimed that before Christmas 1995, the PC maker advertised and sold systems that were to be bundled with a software CD, but the computers arrived without the disc. The FTC charged that Dell didn't tell customers at the time of purchase that the software wasn't immediately available.

Iomega, maker of Zip and Jaz drives, agreed in 1998 to pay its fine after failing to meet federal time limits for redeeming mail-in rebates. The FTC also claimed the company didn't provide merchandise it had offered customers, sometimes not redeeming coupons for more than a year.

But Hippsley says this is the first time the FTC has taken action against online merchants who failed to deliver as promised. Few industry watchers expect it to be the last. Yet as E-retailers know, final approval ratings won't come from the FTC, but from customers. Says GetPlugged.com's Mehrotra: "Consumers are getting smarter and smarter, and if they're burned by a company, they won't go back."

-With additional reporting by Bob Wallace

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