Discount model danger's announcement of 150 redundancies, coupled with up to another 100 at clothes retailer

Ian mitchell

City Briefing's announcement of 150 redundancies, coupled with up to another 100 at clothes retailer, was just the news the e-commerce doom-mongers have been waiting for. They will say this is proof that the fancy valuations given to dotcoms are coming to an end. No matter that the move is based on sound business sense - both are changing the mix of people they employ as the business grows, I share the concerns for many e-tailers. Investors have to decide whether simply changing their sales medium from physical stores to Web sites is enough of a revolution to justify current valuations.

Amazon is probably the most high profile e-tailer. The company has a market capitalisation of $20bn, despite never making a profit. But it has huge brand recognition, massive revenue growth and expansion plans to diversify from books into toys, music and video. Its strategy has been to go hell-for-leather for market domination and worry about things like profits later.

The problem is, the brand has been built on a reputation for discount shopping. Just looking at gross margins gives some idea of the problems it faces - in the nine months to September 1999 (the latest available figures) it made a gross profit of $203m (1998: $80m) on turnover of $964m ($357m). Its gross margin has fallen from 22.5% to 21%, and when you add in expenses you are looking at a $397m loss (1998: $78m).

At the moment, investor euphoria is sweeping all dotcoms higher and higher, with little discrimination about fundamentals such as earnings per share and price/earnings ratios. Some dotcoms deserve their ratings as they are genuinely innovative, have a solid management team and business plan and strong future revenue streams. The worry is that when a correction comes, just as all dotcoms are currently valued as winners, so they will be re-rated as losers.

E-tailers have to decide whether they are offering a service that should command a premium or whether the prime motivation for consumers is cheaper prices. It will be hard to convince the consumer used to discounts that instead they should be paying for the convenience - but that remains the best hope many e-tailers have of justifying their current valuations.

Ian Mitchell is an IT analyst with stockbroker Beeson Gregory. His opinions should not be construed as investment advice.

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