Should eToys Be Shaking in its Boots?

Last week, when giant Japanese conglomerate Softbank Corp. announced plans to take a $57 million (US$) stake in the online operation of Toys “R” Us, the “other shoe” dropped at the headquarters of eToys, Inc.

The reason for the loud thud is that Softbank has been instrumental in the success of such online powerhouses as Web portal Yahoo! and online broker E*Trade Group, Inc. If history is any guide, Softbank will be in a strong position to leverage Toysrus.com’s branding and brick-and-mortar presence to crush eToys.

eToys’ Woes

Despite quadrupling its third quarter sales to $106.8 million, eToys has rattled its shareholders’ nerves by continuing to post significant losses.

Investors are clearly concerned about the company’s effort to spend money on distribution centers — regardless of the long-term outlook. Moreover, third quarter fulfillment costs were much higher than eToys had originally estimated.

Some observers are going a step further by asserting that many investors are beginning to question whether pure-play e-tailers like eToys and Amazon.com will ever be able to turn a profit in the competitive e-commerce landscape without a brick-and-mortar anchor.

Not Too Late

While Softbank bringing its “Midas Touch” to bear is certainly an ominous sign for eToys, there is no guarantee that Toysrus.com will respond appropriately.

For example, even though the online subsidiary staged a major comeback by generating an estimated $39 million in revenues in the fourth quarter of 1999, much of the progress it made unraveled when it failed to deliver holiday gifts on time to several thousand customers.

This meltdown forced Toys “R” Us to offer $100 gift certificates to appease disappointed families, only to have the gesture fail to counter massive negative publicity and prevent an eventual class action lawsuit.

What’s more, it would be an understatement to say that 1999 was a tumultuous year for the company. Early in the year, Toys “R” Us teamed up with Benchmark Capital to fund its online business and attempt to catch up with eToys.

However, the agreement crashed and burned over the summer because the retailer was reluctant to aggressively market its toys online. As the executive shakeups followed, the company’s e-commerce operations were crippled until John Barbour became CEO in September 1999.

Law of Inertia

For my money, even though Softbank may try to lead Toysrus.com into a new world of e-commerce effectiveness and efficiency, I think the Paramus, New Jersey-based retailer will continue to stumble. Nothing in Toys “R” Us’ past history suggests any other kind of outlook.

Therefore, while the law of inertia is currently on eToys’ side, it must quickly establish a partnership with a strong brick-and-mortar retailer and hope that Softbank does not decide to buy a majority stake in Toysrus.com any time soon.