Special Report: Pets.com typifies troubled dot-coms laboring to overcome their missteps

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In the annals of ad spokes-
character history, there are icons such as the Pillsbury Doughboy and the Green Giant that have withstood the test of time. And there are those that soared briefly across public consciousness--remember Budweiser's Spuds MacKenzie?--and flamed out in licensed merchandise dumped in closeout stores.

Then there's the Pets.com Sock Puppet. The white-and-brown pooch with mismatched eyes, an ear-wrenching singing voice and a gleefully snide attitude is the first bona fide advertising celebrity created in dot-com land.

The puppet, created by TBWA/Chiat/Day in San Francisco, has appeared in 13 TV spots, including a $2 million outing on the Super Bowl. He's floated down the streets of New York in Macy's Thanksgiving Day Parade, been a guest on countless talk shows and now stars in his own line of licensed merchandise--everything from plush puppet replicas to T-shirts, calendars, posters, greeting cards and books.

Which chapter of spokescharacter history will carry the Sock Puppet story has yet to be written. But the story of the Sock Puppet and of Pets.com may not in the end be a happy tale.


Yes, the Sock Puppet has generated a great deal of attention for Pets.com, but the question is how much that translates into sales.

The same question, as it happens, has been asked about another TBWA/Chiat/Day dog, Taco Bell's Chihuahua. With Taco Bell sales floundering, parent Tricon Global Restaurants last month fired the agency and has benched the dog--showing how quickly a hot dog can turn cold.

Pets.com faces a bigger question: whether a Web site devoted to pet supplies is a viable business in the long term.

All the accolades for the Sock Puppet don't account for a whole lot right now. Pets.com as a business is in dismal shape. Since the ad campaign kicked into high gear in the fourth quarter of last year, the company has spent more than $3.50 on marketing and sales expenses for every dollar it's generated in revenue. That's $76.6 million in marketing and sales spending from October through June vs. $21.6 million in revenue.

The ratio did improve in the second quarter: Pets.com shelled out less than $2 in marketing and sales for every dollar of revenue ($17 million in marketing and sales expense vs. $8.8 million in revenue). Pets.com's cost of acquiring a new customer--based on a calculation of sales/marketing expense divided by the number of new customers--fell to $95 in the second quarter from a whopping $240 in the first quarter.

"Pets.com is delivering on its plan," Chairman-CEO Julie Wainwright told analysts in a conference call late last month to discuss second-quarter results. "We accomplished everything we set out to achieve" in the quarter.

Investors aren't so sure. The same day Ms. Wainwright made her comments, Pets.com stock hit an all-time closing low of $1.69 a share. That's 88% off the $14 peak Pets.com hit the day it went public in February. (The stock traded at $1.59 in early August.)


Yet arguably, Pets.com did everything right based on last year's rules of the game. This puppy is the poster child of a dot-com, circa 1999.

The free flow of capital into dot-com companies last year resulted in a build-brand-at-any-cost mentality. So Pets.com hired a top creative ad agency, TBWA/Chiat/Day.

The company brought on a rising young star from Procter & Gamble Co. as its VP-marketing. And it crafted an aggressive advertising and promotional campaign that ingrained the Sock Puppet into public consciousness within months of the campaign's August launch.

Pets.com built a robust site. Consumer Reports Online and Gomez Advisors ranked it tops among pet sites. BizRate.com, based on customer surveys, in July gave it 4 1/2 of 5 stars.

The company at the end of the second quarter had 443,000 customers (excluding customers acquired in June with the purchase of assets of Petstore.com), up 68% from the first quarter. Repeat customers accounted for 59% of orders.

Pets.com's second-quarter loss--$24.1 million on revenue of $8.8 million--shrank from the first quarter's eye-popping loss of $39.1 million on revenue of $7.7 million.


But when Pets.com slashed marketing-and-sales spending by 41% last quarter, sales growth slowed. Second-quarter sales grew 14.5% vs. 48% in the first quarter. Sales growth also was far below growth in customers; the company told analysts heavy couponing last quarter--largely to customers of Pets.com investor Amazon.com--pulled its average order below the previous $30 to $40. The company won't say how many consumers came only to buy a $20 Sock Puppet.

In the analysts' conference call last month, Ms. Wainwright said Pets.com is "still focusing on growing our business, but we are also becoming more efficient at the same time."

The company had little choice but to slow spending: Even with its lower marketing spending last quarter, it still burned through nearly half of the $70 million cash it had in the bank as of March 31.


Pets.com is winning on one score: traffic. It trailed rival Petsmart.com until May, when it eked out a slight lead in visitors, according to Media Metrix. In June, Pets.com traffic jumped to a record 1.5 million visitors, far ahead of its rivals. Ironically, those gains came only after it cut marketing spending.

Pets.com has far outspent competitors to establish its brand. Last year, it put $18.8 million into measured media, nearly all of it network and spot TV, according to Competitive Media Reporting.

By comparison, Petopia.com and Petsmart.com spent $9.8 million and $7.9 million, respectively.

In the first quarter of 2000, the spending gap widened; Pets.com plowed 88% of its $19.5 million in media spending into network TV, according to CMR. It ranked in total spending among the top 10 dot-coms, behind far bigger players such as E-Trade Group and Microsoft Corp.'s MSN. Petopia spent just $4.7 million; Petsmart.com, $2.3 million.

(Retailer Petsmart, 48% owner of Petsmart.com, says the dot-com generated first-half sales of $16 million--even with Pets.com--on far lower marketing spending of $20 million.)

In the months ahead, Pets.com could get some TV time without forking over cash; it struck a deal in January with Walt Disney Co., trading equity for, among other things, $11.8 million in media time on ABC.

Those credits will probably come in handy. With the April Nasdaq falloff, investors have become skeptical about consumer dot-com plays. Online retailers are closing up shop virtually every week.

Pets.com VP-Marketing John Hommeyer left in May--right after finishing his one-year vesting period--for Hotwire.com, a discount airline ticket site backed by United Airlines, American Airlines and other carriers. Mr. Hommeyer won't be replaced.

Pets.com is paying the price for its bullishness.

"They were spending very aggressively in order to capture market share, with the belief that they could go back to the capital markets at any time to raise more money," says Greg Kyle, president of Pegasus Research International, which studies Internet company finances. "They pursued a strategy that was very risky and, if it didn't work, there was no other exit strategy."


There's increasing speculation Pets.com may not last the year as an independent company. Industry observers say the company is an attractive takeover target for bricks-and-mortar companies such as Kmart Corp. as well as online rivals such as Petsmart.com.

Some acquirer could see value in the Sock Puppet and the pet site's audience. Pets.com's stock market value in early August was about

$46 million--even with the $45.9 million it spent on sales and marketing in the first six months. Troubled sites can have value: Bertelsmann last month snapped up ailing e-tailer CDnow for a bargain $117 million, giving it traffic and a popular brand.

At least one Pets.com board member says the company is scrutinizing its competitors, leaving open the possibility of some deal.


"Any self-respecting company in times like this is going to have its antenna up," says new Pets.com board member David Chichester, chief financial officer of Hecklers Entertainment, which runs a humor site.

Pets.com declined to make its executives available for interviews for this story, citing "scheduling conflicts." Ms. Wainwright and Chief Financial Officer Paul Manca spent much of the month of July on the road, presumably to raise money.

Earlier this year, Pets.com figured it would need to raise up to $250 million in new cash before it reached the break-even point.

Pets.com now says it can do the job with less than $125 million in new money. That's still a lot to raise given the market's skepticism about the company and the online pet-supply category. While Pets.com's supply of cash is dwindling, Mr. Manca last month told analysts the company believes it can push its funding need into next year.


"We remain absolutely confident of our ability to obtain such funding," the chief financial officer said in the analysts' call. "The bottom line is we will be one of the winners in the overall online retail market."

It's sink-or-swim time for Pets.com.

With Pets.com's stock under water, Wall Street is largely ignoring the company. Only four investment banks cover Pets.com's stock--namely, the four banks that underwrote the IPO. Just three analysts--from those banks--bothered to show up for Pets.com's recent earnings conference call.

The underwriters, who early this year were Pets.com's biggest cheerleaders, aren't talking much about the company these days. Analysts at Merrill Lynch & Co. and UBS Warburg didn't return calls. Analysts who had followed Pets.com earlier this year for the two other banks, Thomas Weisel Partners and Bear, Stearns & Co., no longer do.

Pets.com, looking to the fall, is getting back to business--if not business as usual.

A Pets.com spokeswoman says the company is producing new TV spots for this fall; she says spending has decreased, but declined to provide specifics.

"The level of spending has gone down since we launched the brand," she says. "Our initial efforts were against building awareness. . . . From there, [the plan was that] our marketing would move away from broad, brand building."


A new campaign, more focused on direct marketing than branding, is expected to break this quarter. An individual close to the situation says the new advertising will showcase Pets.com as an advocate for pets and highlight the online retailer's broad selection of products.

TBWA/Chiat/Day executives were not available for comment.

Mr. Hommeyer, the former VP-marketing, is still enthusiastic and insists his departure was simply for a better career opportunity. He calls his time at Pets.com "one of the years I've been most proud of."

"Pets.com is going to win in this space," he says. "It's one of the few dot-coms that's really built a brand and established an emotional connection with consumers."

True, but that's only part of the marketing job. The other part, which is far more important for dot-com retailers, is getting consumers to buy online.

Like many online retailers, Pets.com has engaged in aggressive discounting to woo new customers. The Pets.com spokeswoman says the company is looking for ways to reduce its dependence on the tactic. Mr. Manca told analysts Pets.com expects to trim back its couponing in the second half of this year.


Pets.com has a more serious problem on its hands: It has been operating with negative gross margins, meaning the company has been bringing in less money on items sold than it paid for them. Both of its competitors, Petsmart.-com and Petopia.com, say they are now operating with positive gross margins. (Petsmart.com claims its margins are in excess of 15%.) Pets.com says it expects to emerge into positive territory this quarter.

While consumers may get a slight price break on products--Pets.com and Petsmart.com recently were selling cans of Pedigree dog food for about 67¢ each vs. 79¢ in a bricks-and-mortar grocery store--savings are more than negated by the shipping costs, which start at $4.95 and go up based on weight. And the weight of dog food and cat litter does add up.

In the second quarter, Pets.com's gross margin improved considerably, but remained negative. A move into positive margins this quarter could help Pets.com press the case that there is a viable market for a business-to-consumer Web site devoted to pet supplies.


The people who helped create these pet projects, the venture capitalists, are quick to issue mea culpas for the category's former free-spending ways.

"Pets.com and the pet space generally represented the culmination of all the things that were wrong with b-to-c on the Internet," says Mike Linnert, general partner at VC firm Technology Crossover Partners and a Petopia.com board member. "We spent huge amounts of money and didn't acquire anywhere near the amount of customers we should have. The natural reaction is to say we went too fast and (to) pull back, but what happened is we all started to drink the Kool-Aid and said, 'Spend more. Spend more. Spend more.' "

Branding experts agree that while Pets.com created an attention-getting campaign with all its spending, its biggest mistake has been not delivering on the branding message.

"Most people have a playful, fun relationship with the Sock Puppet, but it has yet to translate into a compelling brand story that makes people want to transact with the company," says Michael Dunn, CEO of Prophet Brand Strategy, a branding consultancy. "Building a brand devoid of a clear business strategy . . . is a recipe for failure."

Pets.com's challenge now is to translate the millions of dollars it has spent on TV advertising into paying customers. It's not going to be easy since competitors have already refocused their energies on customer acquisition and retention tools.

"The days of the landgrab are clearly over," says Andrea Reisman, CEO of Petopia, whose backers include retailer Petco and NBC. "We are increasingly focused on making sure our branding is focused on our customers and not the public in general."

Ms. Reisman takes a pointed jab at her competitor: "We don't advertise on the Super Bowl. That's not where our customer is."


Ironically, Pets.com's biggest asset right now may be the Sock Puppet. The puppet has a lot of fans, but if they aren't pet owners, the brand message is unlikely to translate into sales.

As Steve Hayden, president-worldwide brand services on the IBM Corp. account at Ogilvy & Mather Worldwide, puts it: "There's more to a brand than a lovable spokescharacter." Just ask Spuds MacKenzie.

Copyright August 2000, Crain Communications Inc.

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