INTERNET STRATEGIES: THE SPIN-OFF PAYOFF

Distinct Internet units: the latest trend among mailers

Adult entertainment marketer Playboy is doing it. So is children’s cataloger/retailer Right Start, and pet supplies cataloger/retailer PetSmart. And they are merely following the leads of such marketers as Delia’s, Barnes & Noble, and Creative Computers. All these firms are spinning off, or have already spun off, their Internet divisions to create separate public companies.

For many, the primary motivation is capitalizing on Wall Street’s fascination with all things dot-com. But not all catalogers with separate electronic units have designs on lucrative public offerings – at least not immediately. Some companies view a distinct Web division as a means of ensuring that e-commerce is given top attention.

In fact, the motives for creating separate Web divisions vary as much as the structure of the separate units. Some companies establish units with their own chief executive and budget; others create independent departments that operate autonomously within the organization but ultimately report to existing management.

The details of PetSmart.com’s filing were unavailable at press time, but Playboy.com, which launched in 1997 and includes subscription sites Playboy Cyber Club and Cyberspice.com, and the Playboy and Spice online catalogs, expects its public offering to generate $50 million for the further development of its online business, according to SEC filings. RightStart.com, launched in June 1999, expects to reap an estimated $69 million from its initial public offering.

For these marketers, the benefit of separating their Web units from the rest of the company seems clear: They can share with public investors the burden of financing their cash-hungry e-commerce start-ups, while separating the online units’ inevitable early losses from the bottom line of their mainstream operations.

On the other hand, North Canton, OH-based Kids Stuff, mailer of the Natural Baby, Perfectly Safe, and Jeannie’s Kids Club children’s merchandise catalogs, established a separate Web division in February to better focus on growing its online business.

“We decided to separate the Internet business from our catalog operations when we saw online sales jumping to 7%-8% of our revenue without any advertising,” says William L. Miller, CEO of the $17 million Kids Stuff. “In my experience, whenever you try to do two things within the same organization, one of them gets buried. We wanted to make sure we were fully committed to the Web without losing focus on the catalog.”

Although Miller doesn’t see the Web division filing an IPO in the foreseeable future, he allows that it is modeled in the manner of a fully autonomous company with its own leadership and budget lines – necessary steps in preparing to spin off. “Right now we’re more likely to explore a joint venture or maybe a merger with an established dot-com company. We could exchange our knowledge of fulfillment for their online expertise and resources.”

The entrepreneurial spirit

W.W. Grainger’s recent decision to create three separate e-commerce businesses was designed to foster an entrepreneurial atmosphere within the $4.14 billion company. “We’re reallocating some of our talent and reassigning some of our younger players within the organization to give them a chance to run with the ball,” explains Dileep Gangolli, spokesman for the repair and maintenance products marketer.

Grainger’s three e-commerce units are OrderZone.com, a portal through which small businesses can buy supplies from a consortium that includes five outside companies; FindMRO, a service for locating and purchasing obscure items ranging from bear repellant to giant stir sticks for paint vats; and Grainger Auction, a product liquidation site. Each of the three units will have its own president, who will report to Donald Bielinski, the president of the Grainger brand group. (W.W. Grainger’s other brands include the Lab Safety Supply catalog.)

Yet Grainger’s flagship Internet property, Grainger.com, will not be separated from the marketer’s main industrial supply unit, though it will have its own president, James T. Ryan, the industrial supply unit’s former vice president of information services. “We view Grainger.com more as another distribution channel,” Gangolli says.

Although Grainger’s three e-commerce units don’t operate autonomously, Gangolli allows that they could be spun off, albeit in the distant future. “The architecture is there. Right now, the businesses would lose money, and they would keep losing money because of [the investment needed]. But it may be that they’d surpass the rest of the company eventually.” In 1999, Grainger posted $102 million in Internet sales while investing $44.4 million in its Web businesses. While the units’ combined staff has mushroomed to 230 employees in three years, the day it overtakes the rest of Grainger’s operations (which employ about 16,000 workers) appears a long way off.

Only a temporary boost?

While the Barnes & Nobles of the world have raised millions by transforming their e-commerce divisions into independent public companies, John Dempsey, a Chicago-based analyst with Barrington Research, believes that investors are not as enamored of dot-com IPOs as they were a year ago. “Internet commerce still holds some cachet among investors, but I don’t see that spinning off [an e-commerce unit] would create a true business advantage. I expect investors might not, either.” Dempsey believes that whatever initial infusion of cash a cataloger might receive from an Internet IPO would be unlikely to generate long-term investment interest. “A spin-off may provide pizzazz, but it’s only temporary.”

Some catalogers may also fear that in the eyes of investors, a spin-off could dilute the value of the core company. Certainly in its fully subscribed secondary public offering in July, upscale gadgets cataloger/retailer Sharper Image played up the value of its multiple channels by prominently detailing its intention to step up online marketing activities.

What’s more, by keeping the company intact, “we’re able to repurpose the same resources that make the catalog successful,” says Kathryn Grant, spokeswoman for the San Francisco-based Sharper Image. “By using the artwork and copy, we can transition our brand quickly and easily to the Web.” And the $293 million marketer relies on its back-end systems to seamlessly service customers across all distribution channels – an advantage it fears would erode if the Internet unit were spun off.

Sharper Image is also concerned that separate divisions would dilute its talent pool. “We wouldn’t lose talent, but sharing would become more complicated. We’d also have to create a new board and split the president’s time. Right now our heads of creative, our president, and our CEO are involved in all channels,” Grant says.

In short, Sharper Image – like other catalogers that want to keep their Web divisions integrated with the rest of the company – believes that the parts are greater than the whole.

Answering the following questions may help you decide whether to spin off your e-commerce division:

1) Can your existing staff and management commit enough creativity and energy to grow both your online and offline businesses?

2) Will splitting operations reduce the number of talented marketing people available to one or both of the new units?

3) Can you afford to fund a Web start-up that includes additional and often redundant expenses, and that eliminates the efficiencies of some shared resources?

4) Will separate management teams ultimately create separate – and perhaps conflicting – messages about your brand

5) Can you demonstrate that your Web unit, once independent from other operations, can eventually offer investors sufficient return for their money?

6) Are there enough high-quality advisers available in your market to sit on a new board?

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