After The Gold Rush: The Internet’s Role In The Surf Industry, One Year After.

Editor’s Note: The dotcom world remains volatile, dynamic, and fascinating — especially in the surf industry. Since this article appeared in the last issue of TransWorld SURF Business, significant changes have occurred at Swell.com. See the end of the story for Jeff Harbaugh’s latest update.

About a year ago I wrote an article that appeared here in TransWorld SURF Business about what it would take to be a successful company on the Internet. At the time, the Nasdaq had taken its first of an ongoing series of plunges — rocking Internet-related stocks to their core.

During the same time, the surf industry was also wrestling with what to do with the procession of dotcom startups offering the action-sports market both editorial content and an e-tailing component. Meetings were occurring at a rapid-fire pace as marketing managers and merchandisers struggled to choose the best online partnership and strategy. Staying on the sidelines was viewed as out of the question and was most often met with sly smirks and knowing smiles from competitors.

Back then I concluded that unless a lot of revenue came from sources other than product sales, it would be hard to see a viable financial model in these surf e-tailers.

Well, here we are today. From 60 Minutes to fuckedcompany.com, the Internet’s “Highway of Death” has been well analyzed and reported. What isn’t so clear is how all this has affected the surf industry. Are there still profits to be made from surfers surfing the ‘Net? If so, whose chances are best, and which strategies are they using?

 Internet business generalization number one: There’s no such thing as a successful Internet business, just successful businesses that can competitively provide a product or service to a defined customer base that happens to use the Internet. The Internet is not the source of their competitive advantage and is not their key differentiator, although it facilitates the delivery of their product or service.

**** Becker: Existing Inventory, Minimal Risk ****

Becker is a twenty-year-old, successful, ‘core surf retailer with four (going on five) shops in Southern California. The brand’s competitive advantage, according to CEO Dave Hollander, is that it sells California culture without bastardizing it. To maintain this competitive advantage, Becker has intentionally limited its growth to preserve the company’s culture and market position.

Its Internet site, www.beckersurf.com, first went up three and a half years ago — practically back in the late Bronze Age in Internet years. Becker was already credible when its Internet presence was established, so it avoided the additional cost of building a brand. Because of the long-term relationships Becker has with its vendors, it was easy to convince brands to allow their product to be sold on Becker’s Web site, says Hollander. Becker’s Web site never discounts product. In fact, some items end up selling for more than they sell for at a store.

Becker doesn’t buy inventory specifically for the Internet. “Well, no kidding,” I said the first time Hollander told me that. But as we talked a little more, the significance hit me.

Hollander knows what will sell in his stores and what won’t. On the Internet, he says, it’s a different story: “The challenge of inventory management if you don’t have retail stores is overwhelming on the ‘Net.”

If you’re an Internet-only retailer, how do you choose and manage your inventory? If you never know who your customer is going to be or where they live, how do you order for them?

A brick-and-mortar store gets its customers locally and can learn about purchase patterns. The only thing Hollander knows for certain about purchasing patterns on his site is that orders from Indonesia almost always represent credit-card fraud — and he won’t ship to them. In fact, Becker’s biggest Internet problem is credit-card fraud, estimated to be ten to fifteen percent of orders received (but, happily, not of orders shipped).

With existing brand recognition and inventory already in place, Becker has a svelte Internet business model that minimizes risk and expense. It’s no secret that retailers are figuring the Internet out. Beckersurf.com has a head start because of when it launched. As long as its Internet presence is an extension of its successful brick-and-mortar presence, I suspect they will continue to succeed on the Internet.

 Internet business generalization number two: Few companies selling only to consumers can make a profit strictly through e-tailing. The Internet is only a tool.

**** Swell: Coming To A Corner Near You? ****

Last year, Swell was just one of the nascent brands in a market crowded with competitors. But with the demise of Hardcloud, Boo, Broadband Sports, and others, and with the restructuring of Bluetorch, the playing field has become eerily quiet.

Couple this with the broad coverage the Cortes Banks expedition gave Swell, and you’d think the brand would be the likely survivor of the ongoing dotcom crash.

Despite this, rumors about Swell being bought, running out of money, or going out of business are as common as fleas on a stray dog, and passing along those rumors seems like an industry obsession. In response, Swell CEO Doug Palladini says: “Swell is not in imminent danger of running out of money. Funding was obtained consistent with a financial model showing profitability by the end of 2001.”

Currently, Swell’s revenue model includes e-tailing, advertising, catalog sales, and content syndication. Soon, says Palladini, Swell will add a fifth source of potential revenue when it joins the crowded ranks of brick-and-mortar retailing.

According to Palladini, the Swell business model — since its earliest inception — always included brick-and-mortar retailing. He isn’t prepared to be specific about how or where Swell with launch its stores or what it will all cost. Nor will he answer questions like, “How much money do you have in the bank?” or “How much are you spending each month?” — although both topics have been grist for that rumor mill.

Swell also includes Crossrocket and Monsterskate for the snow and skateboarding markets, respectively. According to a mission statement posted on the Web site, Swell’s goal is to be “the definitive sources, regardless of medium, in the sports and cultures” and is “to produce content of unparalleled quality and depth aimed at the core of each market, yet will appeal to the broader lifestyle audience as well.”

These are lofty — and just the slightest bit generic — goals. And expensive to achieve. Given the expense, how do you make money at it?

When you factor in the Monsterskate and Crossrocket brands, the five revenue sources could become fifteen. Add Surfline to the mix and you reach sixteen. Of course, not all these segments are really distinctive — no doubt there may be some skate or snow product in the surf retail stores, for example. There’s significant crossover and, Swell hopes, synergies.

Swell’s first challenge is to build its brand name — or maybe three brand names, since it seems intent on doing the same with their skate and snow sites. Its next task is to gain loyalty from a customer base somebody else either has or wants. Getting these customers requires Swell do e-tailing, brick-and-mortar retailing, and catalog sales at least as well or better than other e-tailers, brick-and-mortar retailers, or mail-order-catalog businesses.

 Internet business generalization number three: The Internet does not create new customers. Okay, there may have been some kid who stumbled across an e-tailer when he was trolling for porn and bought something, but that doesn’t amount to a hill of beans, and he probably would have bought it anyway at a traditional retailer.

Back to the issue of expense. Somebody who’s in a position to know told me that opening a new surf shop requires between 180,000 dollars and 225,000 dolla
rs in inventory, plus 100,000 dollars to 250,000 dollars in up-front expense. Swell will have the same brick-and-mortar retail-expense structure as any other brick-and-mortar retailer, as well as the same catalog expense structure as any other catalog retailer, and the same e-tailing expense structure as any other e-tailer. This is on top of the cost of its editorial staff. And producing top-quality editorial content — which I agree is critical to their strategy — ain’t cheap.

Swell’s most daunting challenge is to make one and one equal three — or at least more than two. Swell has to represent such a ubiquitous or compelling buying opportunity that a consumer who would normally buy 100-dollars worth of stuff ends up spending more.

How much more? Who knows? But if that doesn’t happen, Swell may be creating convenience for the consumer, but they’ve got a bigger expense structure that has to survive off the same amount in sales as their competitors.

Fundamentally, I like their “brandcentric” concept, but it ultimately boils down to whether Swell can get big enough, fast enough — and create enough brand legitimacy — that its five revenue sources can feed off each other and justify the expense structure. It hasn’t worked for Amazon yet.

 Internet business generalization number four: Whatever you do on the Internet, it’s easier if it doesn’t involve consumers. Maybe that’s not only the case for the Internet.

**** Hub360: If You Build It, Will They Come? ****

When it launches in the second quarter of 2001, Hub360 will join other existing business-to-business Web sites catering to the action-sports industry — but will have a more refined focus on the surf industry. As envisioned, Hub360 will allow retailers to browse online catalogs, check inventory, place and track orders, access order history, and use online forecasting tools. Suppliers will be able to track retailer status.

Most suppliers may not have the time, energy, focus, or money to develop their own site that can do everything the Hub site will do. The benefit to the retailer is that they won’t have to learn a different system and functionality for each supplier.

There will be no charge for retailers to access the various supplier spaces once approved by the supplier. Hub will make its money the same way as somebody who runs a trade show. A company can have as big a presence on the Web site as they want, and they will be charged accordingly.

Hub President Dan McInerney stresses that this is a service business that happens to do business on the Internet. He’s helping suppliers by outsourcing certain tasks they have to perform but that don’t represent critical competencies to them. He believes Hub can do them better and cheaper.

Some suppliers seem to agree. McInerney says he has letters of intent from more than a dozen of the biggest companies in the surf industry, representing apparel, footwear, optics, wetsuits, and accessories.

The system won’t work if retailers ignore it, but McInerney has signed letters from 50 top retailers saying they will use the site, giving the suppliers some assurance that the cash they pay Hub won’t be wasted. Hub360 expects to be profitable in its first year of operation if nothing happens except that the twelve suppliers sign on the dotted line.

Hub’s focus will be on the surf and skate markets, because that’s the industry they know. In fact, the main advantage Hub360 has over its competitors are the existing relationships those working on Hub have within the surf market.

All the suppliers are already doing what Hub will do for them. For better or worse, brands already have the systems and resources in place. Resistance to change can be a powerful force, and it will be interesting to watch how Hub360 overcomes this fact.

Suppliers will still have to physically handle the product, and that’s where much of the cost lies in the activities Hub will facilitate. I can imagine the benefit from working with Hub will be from providing better customer service and having more accurate, timely information — rather than from overall cost reductions achieved.

The concept seems to make sense, but it’s a hell of a lot easier to evaluate an operating business model than a concept that has yet to see the light of day.

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5/11/01 Update: Swell Raises $2 Million. Is That a Good Thing?

Almost as soon this article was finished, Swell fired the staffs from its Crossrocket and Monsterskate sites and announced it had raised $2 million in bridge financing. I hate it when that happens.

Rather than just throw up a press release that created more questions than it answered (see it below) TransWorld SURF Business asked me to track down new Swell Chairman and CEO Bob Allison and ask him what was up. It required a fairly impressive game of phone tag, but we managed to connect. Hopefully you’ll agree that the additional information was worth the wait.

The headline on the press release was about a $2 million bridge, so the first question was “Bridge to what?”

The two-million dollars is a loan convertible to equity. Mr. Allison confirmed that Swell had burned through most of the capital it had raised (most recently, eight-million dollars raised last October). The two-million dollars”gives the investors time to evaluate how to move forward with the appropriate plan,” said Mr. Allison. He indicated that investors had committed to invest an additional five-million dollar in Swell consistent with the company demonstrating to them a viable business plan and revenue model.

So the additional five-million dollars is “committed” but not in the bank. It’s hardly surprising to learn that investors won’t throw money at a company until they understand the business model.

The money raised towards the end of last October lasted six months or a little longer. That’s a burn rate of something like 1.3-million dollars per month. Obviously, Swell has moved to reduce that—including laying off 26 employees and relocating the Swell media offices to Huntington Beach, which Mr. Allison confirmed.

Swell’s actions in containing costs are consistent with what other surviving dotcoms have had to do and, in any event, just make good business sense. But of course, no matter how much you reduce costs, you also have to grow revenue to demonstrate a viable business.

That business, according to Mr. Allison, will focus around the catalog and ecommerce business. Brick and mortar may still be in the picture, but only in the longer term. Since launch, Swell has generated more than 1.5-million dollars in revenue in spite of having essentially missed the Christmas season. Four-hundred-thousand dollars of that was in the last month, so it appears that revenue growth is accelerating. Swell’s four catalogs have had a combined circulation of 1.6 million, and Swell has shipped more than 25,000 orders.

Still, they clearly have to grow revenue, reduce expenses, and raise more money for the business model to succeed. The alternative is to make a deal.

Like with Surfing, for example.

Allison pointed out that Primedia—the owner of Surfing Magazine—has been an investor in Swell since its inception. He said that the two companies see significant potential synergies between what Swell is doing online and what Surfing is doing off-line. He acknowledged that there were discussions ongoing, but that no deal had been reached as of this time (May 11th). He expects a conclusion to those discussions in the next couple of weeks.

Here’s the press relase that appeared on VentureWire on May 3, 2001:

****Online Surf and Skate Resource Swell Gets $2 Million Bridge ****

Swell, a provider of Web sites, content, and commerce relating to surfing, skateboarding, and snowboarding, said it has received a $2 million convertible bridge investment from all previous investors on a pro rata basis.

In a written statement, Bob Allison, partner with Edg
ewater Equity Funds and a Swell board member, said, “With the current market conditions and some adjustments to the Swell business model, we are discussing the appropriate valuation and the next phase of capital.”

CEO and chairman Jeff Berg has resigned from the company, but remains on the board. Mr. Allison said that Mr. Berg is managing partner of Matador Capital and was only at Swell on an interim basis. Swell.com, which also operates a surf and skate catalog business, is backed by Bluestem, Edgewater Funds, Matador Capital, and Richland Ventures.

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About The Author:

Jeff Harbaugh has an MBA from the Wharton School of Business and twenty years of experience helping company owners manage issues of transition — the last ten in the action-sports industry. Reach him at (206) 232-3138.