Egghead Scrambles to Virtual Retailing

Following a day-by-day tactical schedule, store managers marked down remaining inventory, advertised closing sales, and finally furloughed their employees and themselves. In February, when the plan was executed, Egghead Computer, a once-thriving retail chain selling personal computer hardware and software, disappeared from the material world. A mainstay of suburban malls nationwide with 250 stores at its peak in 1992, the Spokane, Wash.-based company was closing the doors to its remaining 80 shops.

But Egghead, founded in 1984, didn’t vanish like that 19th-century remnant, Woolworth. Instead, the company reappeared in a virtual venue that many observers expect to be at the heart of 21st-century retailing: the World Wide Web. Renamed Egghead.com, the company’s operations are no longer in rent-laden storefronts but on three low-overhead Web sites-colorful, catalog-style markets that sell all things computer-related. It has become in effect a virtual mall, with a flagship outlet for new goods (www.egghead.com), a bargain warehouse for refurbished or discontinued products (www.surplusdirect.com), and an online auction house for avid bargain hunters (www.surplusauction.com).

In place of display shelves of boxes of hardware and software, Egghead now offers postage-stamp-sized graphics on your computer screen and brief text descriptions of PC hardware and software. What the new Egghead lacks in kick-the-minitower physical immediacy it makes up for in convenience. In three mouse clicks from the main site’s opening page, any visitor with a valid credit card can fill out and expedite an online order form for a purchase 5 percent to 10 percent cheaper than it would have been in an old Egghead store. Anyone nostalgic for a salesperson can visit an area called the Palace, where a real Egghead employee displayed as a cartoony avatar can converse with you (virtually, of course).

Egghead is not the first online retailer. Assorted startup companies have pioneered popular Web-only commercial outlets for books (Amazon.com), audio CDs (CDnow) and stocks (E*Trade), but this marks the first time that a large established firm has completely abandoned physical retailing in favor of the virtual marketplace. The action has been viewed as a gutsy last resort for Egghead, following a string of unfortunate management decisions.

It wasn’t just bad business strategy at the top that prompted this move. Retail sales are inherently cyclical, subject to economic trends and marketing fads. In addition, software retailing since 1992 has been in the throes of change. Microsoft and a handful of other publishers have come to dominate the applications program market, leading to a loss in retail sales margins. Shifting to include more hardware offerings, the company changed its name from Egghead Software to Egghead Computer. But that repositioning was undermined by a series of costly business moves. One executive, for instance, ordered an expensive warehouse change because he didn’t like the neighborhood where the company’s main storage facility had been located. In another misstep, Egghead got rid of its corporate sales force, which had been a major source of revenue.

Even without such blunders, Egghead faced mounting pressure from larger-scale retailers such as CompUSA and Wal-Mart. Egghead was hemmed in by the smallness of its shops, which typically inventoried 2,000 different items or “stock-keeping units” (SKU) in the jargon of the trade-hardly enough to compete with the 5,000 SKUs available at nearby computer, office supply, or buying club superstores. Egghead was especially vulnerable because many of its leases were due for renewal 10 years after its greatest expansion, and the new rentals would have been prohibitive. In response, the company attempted to become an all-superstore chain, opening three large-scale retail outlets. But these stores cost as much as $4 million each. Egghead was in the midst of a dismal period, losing money in 10 out of 12 quarters during 1995-98. A makeover of its remaining stores amid this prolonged financial hemorrhage proved too daunting.

To correct the course, Egghead management-which had already closed theleast profitable stores-opted for a different tack. The bold strategy: stop trying to lick the superstores. Instead, attempt to capitalize on the unique brand equity earned by Egghead over nearly 14 years in the physical world and transform the operation into an online-only retailer.

At 54, Egghead Chairman and CEO George Orban is a thinning-haired patrician who vaguely resembles the Egghead brand’s shiny-pated inspiration, Adlai Stevenson. According to the company’s Web site, the term “egghead” was “originally applied to an intellectual who supported Stevenson’s presidential candidacy” in 1952 and 1956-elections that Stevenson, much loved by highbrows, lost in landslides to Dwight Eisenhower.

With little technology background in his career as a venture capitalist and retailer, George Orban might seem an unlikely champion of e-commerce at Egghead. He had to be called out of retirement after leading the turnaround of Ross Stores, a failing department store chain he transformed into a successful discount clothing retailer. Orban was drafted by the corporate board of Egghead, in which he had been an early investor. In 1996 he was named chairman. In January 1997, he also became the company’s CEO to turn around the ailing firm.

“This isn’t an evolution I recommend for every company in the physical world,” Orban tells hundreds of attendees at the Jupiter Shopping Forum, an electronic commerce trade show in New York City in April, three months after the announcement of Egghead’s complete withdrawal from real-world stores. “The virtual world is not going to dispel the physical world.”

On the dais with Orban for a session titled “Reinventing Retail: Defining the Interactive Shopper” sit e-commerce peers representing CyberShop, a fee-charging shopping club site; the online version of television’s successful QVC shop-at-home service; and the emerging new media juggernaut, Disney Online. “Our brand was a very powerful element in our decision,” says Orban. Indeed, much goodwill still attaches to the Egghead name. The company’s Customer Upgrades and Extras (CUE) discount card, good for a 5 percent discount on most merchandise and a victim of the store closings, is still carried in many a Silicon Valley entrepreneur’s wallet.

Shutting the retail stores was a costly gambit. According to Egghead’s annual report, the closings poured $37.6 million in expenses into the company’s river of red ink, including $2.2 million for severance and other costs in cutting 800 jobs-80 percent of the company’s remaining work force. In the process, Egghead cut off its primary source of revenue (sales at its stores), a scary prospect for any enterprise.

“With the benefit of 12 weeks’ hindsight, I think we were absolutely right,” Orban comments immediately after the e-commerce panel. Easing his decision was the company’s firsthand knowledge of Internet commerce through the acquisition of Surplus Direct, a successful Web-based computer goods liquidator, with real-world offices in Hood River, Ore. While providing practical systems experience in taking and fulfilling online orders, Surplus Direct also gave Egghead an auction site for odds and ends and a closeout site equivalent to Filene’s Basement, the Boston-based chain of apparel stores. Recalls Orban: “In the fall of 1997, we relaunched www.egghead.com, which had been a corporate identity site. After that we decided we could shut down the remaining stores.” The last vestiges of the old business-a toll-free telephone number to order items from printed catalogs-will be phased out within the next year.

According to the first annual report after its store closings, Egghead’s most spectacular expansion came on the Surplus Auction site, where total registered bidders shot up to 168,000 in June, from just 29,000 nine months earlier. By July, the Web survey firm MediaMetrix was reporting that traffic on all three Egghead-owned sites made the company the seventh most popular electronic commerce site on the Web. Egghead trailed bookseller Amazon.com as well as C/NET Software Download Services, a direct competitor.

Unfortunately, registrations and visits alone don’t pay the bills. Egghead reported a loss of $39.6 million for the fiscal year that ended in March, a sharp increase in losses from the $10.7 million of the previous year. In conversation in New York, Orban is candid about further losses: “For the foreseeable future, we don’t see this as a period of reaching for profit. This is a period of transition. We are investing the resources of the company for the future.”

Orban could be right. Though it’s still too early for solid conclusions, first indications hint at online retailing initiating Egghead’s long-hoped-for turnaround. In the first full quarter after the last store closings, expenses were half those of the previous quarter. Shutting its physical storefronts cut $7 million in expenses directly, and led to savings of another $2 million in corporate administrative costs. During the same period, online orders rose 41 percent-to $21.1 million in the quarter ending July 30.

The securities market seems to have taken these signs of healing seriously. This summer, Egghead stock (NASDAQ abbreviation: EGGS) was borne aloft by a wave of Internet speculation on Wall Street. Selling at $6.50 a share when Egghead’s e-plans were announced, in five months its price rose and fell to about $8.50 at the start of July. Then in the same spurt of buying that made Broadcast.com the fastest-rising stock in the history of initial public offerings, Egghead shares more than tripled in value over the next two weeks before settling to $17.87 by July 30, some six months after Orban’s store-closing announcement.

Was this the start of continued fast-growing valuation of Egghead by savvy financial markets or just a bout of online investment mania by latecomers to the high-tech stock surge of the ’90s? It’s too soon to know, but differing opinions are easy to find. “I think Egghead management made a great decision,” says analyst Casey Stern of Starr Securities. “Egghead has a great deal of brand recognition, and it’s transferable to the Web. Now they can concentrate on the business of selling.”

Industry consultant Frank Catalano, marketing manager for Egghead in its heyday from 1988 to 1992, is less upbeat. “I would like to be proven wrong, but they’ve taken every bad turn they could,” he says. At the heart of his critique of Egghead’s e-commerce-only business model is what he called “a huge fallacy” that online retailing will largely displace physical stores. “At most only 25 percent of the United States is hooked up to the Web, and retail stores will remain an important physical presence for shoppers for a long time to come,” says Catalano.

Nor has the transition to e-commerce been without tension. The Web-using public, perhaps spoiled by promises of instant gratification, can be an ornery lot. A company that thrives on the Web can also die on the Web, given the medium’s accessibility to opinions of all stripes. There is, for example, a personal page titled “Egghead.com Sucks Big-Time!” that includes the admonition “Buy Elsewhere!!!!!” and a compilation of complaints from dissatisfied customers. Such pages are as easily located via Web search engines as Egghead.com’s own sites.

At the end of the Jupiter Shopping Forum panel, Orban reveals to the audience that in the long term, Egghead is looking beyond computer hardware and software sales. He says: “On the Web, we’re in the business of aggregating customers. We think we’ve figured out how, over time, we’re going to make money. It sure as heck isn’t going to be in the commodity business of selling highly visible branded consumer high-ticket durables.” In other words, as the personal computer business becomes more mass-market, and buying decisions are increasingly driven by price, it is better to be in other sales arenas. Gathering visitors through its memorably named Web portal and providing links to other commerce sites could offer Egghead additional sources of revenue.

Already, Web sales powerhouse Amazon.com has expanded beyond books into music and then into everything else with the acquisition of Junglee, an online personalized buying comparison service, prefiguring the infrastructure for a virtual superstore of its own. As for Egghead, its Surplus Auction site already sells consumer electronics products and jewelry. How long before Egghead.com expands into a full-line online superstore?

It is to Egghead’s good fortune that its 1980s-coined name still sounds fresh and irreverent, ’90s Web-style. On the Internet, there’s no reason at all why Egghead can’t become the online Wal-Mart of tomorrow. But even in the fast-paced world of e-commerce, it’s going to take some time to find out whether Egghead has successfully reinvented itself-or simply prolonged its demise by imploding from brick-and-mortar stores into a virtual enterprise.