Internet Mini Case 4

eBay

Maryanne M. Rouse

“June 2, 2002 - WASHINGTON: The U.S. Air Force is looking into the Internet auction

of sensitive government aircraft-communications equipment. The sales on eBay Inc.'s

online auction site, which were reported by Newsweek magazine, were of parts used in

aircraft like the SR-71 spy plane and F-16 fighter. "It is actively under investigation by

the Air Force Office of Special Investigations," an Air Force spokesman, Capt. David L.

Englin, said Sunday. Antiques dealer Norb Novocin told the magazine he bought the

parts in Jacksonville, Fla., for $244 in an unclaimed property sale. The seller was a

shipping company which had been hired to take the parts in 1989 from Dover Air Force

Base in Delaware to Warner Robins in Georgia, the magazine reported. Mr. Novocin

said that he initially called the Georgia base about buying the goods but was turned away.

After he was contacted by the Air Force, Mr. Novocin said he turned over the names and

addresses of purchasers and agreed to stop selling the equipment.

© 2002 Dow Jones & Company, Inc.”

In 1995, eBay pioneered online personal trading by creating a web-based platform to bring buyers

and sellers together in an efficient, entertaining auction format to buy and sell items

______________________________________________________________________________
This case was prepared by Professor Maryanne M. Rouse, MBA, CPA, University of South Florida. Copyright © 2005
by Professor Maryanne M. Rouse. This case cannot be reproduced in any form without the written permission of the
copyright holder, Maryanne M. Rouse. Reprint permission is solely granted to the publisher, Prentice Hall, for the
books, Strategic Management and Business Policy – 10th Edition (and the International version of this book) and Cases
in Strategic Management and Business Policy – 10th Edition by the copyright holder, Maryanne M. Rouse. This case
was edited for SMBP and Cases in SMBP – 10th Edition. The copyright holder is solely responsible for case content.
Any other publication of the case (translation, any form of electronics or other media) or sold (any form of partnership)
to another publisher will be in violation of copyright law, unless Maryanne M. Rouse has granted an additional written
reprint permission.

Internet Case 4-1

ranging from antiques, high-end artwork, automobiles, electronics, and jewelry to the practical,

arcane, pure kitsch, and downright bizarre - as demonstrated by Newsweek’s report of the sale of

sensitive aircraft communications equipment on the site.

eBay began as a no-registration, no-fee, grassroots trading company called Auction Web in

September 1995. After its listing on the National Center for Supercomputing Application’s

“What’s Cool” list, the site’s popularity soared. Minimal fees were introduced, and by March

1996, the company turned its first profit. eBay was incorporated in California in May 1996 and

reincorporated in Delaware in 1998; the company went public in 1998.

The eBay dynamic pricing (auction-style) format permitted sellers to list items for sale, buyers to

bid on items of interest, and all eBay users to browse through listed items. Through wholly and

partially owned subsidiaries, the company operated trading platforms targeted to the United

States, Australia, Austria, Belgium, Canada, France, Germany, Ireland, Italy, the Netherlands,

New Zealand, Singapore, Spain, South Korea, Sweden, Switzerland, and the United Kingdom.

(eBay exited the market in Japan in 2002.) The company’s consumer base had grown from

individual consumers to include merchants, small to medium-size businesses, global corporations,

and government agencies. eBay also provided offline, traditional auction services for fine arts,

antiques, collectibles, and collector cars. Online services accounted for 95% of 2001 revenues,

with offline auctions accounting for 5%.

Online Services

Internet Case 4-2

eBay defined the online services segment to include U.S. and international online trading

platforms as well as key features offered through those platforms, including electronic payments,

photo hosting, Buy-It-Now, and third-party advertising.

The eBay trading platform was a fully automated, topically arranged, easy-to-use online service

that was available 24 hours a day. Anyone could visit eBay and browse through the items for

sale; however, only registered users could bid on and list items for sale. The registration process

was both easy and quick, allowing users to bid on and list items immediately. Registered sellers

could list an item for sale by completing a short online form, selecting a minimum price for

opening bids, and choosing whether the listing would expire after 3, 5, 7, or 10 days. The seller

could also indicate a reserve price, the minimum price at which the seller would be willing to sell

the item; the reserve price was not disclosed to bidders. At the time of listing, sellers could also

choose to use the Buy-It-Now feature, which allowed the seller to set a price at which he or she

would be willing to sell without waiting for the auction to end. Sellers with multiple identical

items to sell could take advantage of eBay’s “Dutch Auction” feature, which allowed the highest

bidders (the number of bids equal to the number of items) to all receive the item at the same

price. Only sellers with sufficiently high feedback ratings could use the reserve and Dutch

Auction features.

eBay’s core business model was still person-to-person selling, which accounted for the largest

percentage of its revenue. The company generated revenue from listing fees, feature fees, and

final value fees. There was no charge to buyers; however, sellers paid a small placement fee to

list an item:

Minimum Bid, Opening

Value, or Reserve Price Listing Fee

Internet Case 4-3

 $ 0.01 - $ 9.99 $ 0.30

$10.00 - $ 24.99 0.55

$25.00 - $ 49.99 1.10

$50.00 - $199.99 2.20

$200.00 and up 3.20

eBay generates additional revenue by offering sellers opportunities to enhance their listings by

adding features to attract buyers:

Seller Feature Description Fee

Featured on Home Page Item listed in a Special Featured section and

also rotated on the eBay home page $99.95

Featured Plus! Item listed in the category’s Featured Item

section and in the bidder’s search results $19.95

Highlight Listing is emphasized with a colored band $ 5.00

Bold Item title is listed in bold type $ 2.00

Buy-It-Now Allowed the seller to close an auction instantly

for a specified price $ 0.05

Internet Case 4-4

Final value fees were based on the selling price. The fee for items sold at up to $25 was 5.25% of

the sale price. For items sold at between $25.01 and $1,000, the fee was 5.25% of the first $25

plus 2.75% of the amount over $25. For items sold at over $1,000, the fee for the first $1,000

was as above, with an additional 1.75% of the amount over $1,000.

When an auction ended, the eBay system validated whether a bid had exceeded the minimum or

reserve price. If so (or, if the buyer elected Buy-it-Now), eBay automatically notified the buyer

and seller via e-mail. The company never took possession of the item; the buyer and seller

arranged for shipment and payment; the buyer typically paid for shipping. Although eBay had

no power to force a buyer or seller to complete a transaction, it could ban repeat offenders from

trading on the site

Platform enhancements included Trust and Safety Programs such as the Feedback Forum,

SafeHarbor, and other differentiating features such as My eBay. The Feedback Forum

encouraged users to record comments, both favorable and unfavorable, about their trading

partners. The company organized feedback to create user profiles that contained complaints,

criticisms, and positive comments and included ratings. Users who developed good reputations

had color-coded star symbols placed next to their user names to indicate the number of positive

feedback ratings received. eBay users were encouraged to review a seller’s feedback profile

before bidding on an item. The company’s SafeHarbor staff investigated users’ complaints of

possible misuse of the site and could take actions ranging from issuing warnings to suspending

users from bidding or listing items for sale. My eBay gave users a report of their recent activity,

including bidding, selling, items bidders were watching, account balances, favorite categories,

and recent feedback. Users who had their own web pages could create links to their home pages;

those without home pages could use About Me to create them free of charge.

Internet Case 4-5

eBay monitored the trading activity in existing categories and, when it saw sales of merchandise

picking up in an area, it created a new trading category. In late 1998, for example, eBay noticed

that users were beginning to sell full-size cars in an area of the site devoted to toy and collectible

cars. The company formed a separate auto category, and within two years, the annualized value

of cars and car parts sold through the site exceeded $1 billion.

Business and Industrial Sales

In early June 2001, eBay announced that it would create stores on its web site featuring goods

from retailers. Recognizing the significant revenue growth opportunities offered by large

businesses, eBay began successfully cultivating such corporate sellers as IBM, Xerox, Dell,

Home Depot, Motorola, the U.S. Postal Service, ReturnBuy (a closely held merchandise

liquidator), and eValueville (one of the largest liquidators of apparel for Bloomingdales). By

early September 2002, at least 71 large companies were selling outdated merchandise, from

laptops to tractors, on eBay, up from just a dozen a year earlier. The key driver of growth in

eBay’s business and industrial sales segment was that sellers could recoup $.45 on the dollar for

excess inventory rather than the $.15 - $.20 they could expect from traditional liquidators. For

example, Motorola, which started using online auctions in April 2002, sold $1 million of outdated

phones a month. While many items were sold in lots, individual items, such as high-end photo

equipment, also sold well. Such sellers were contributing to a shift in the composition of goods

sold on eBay from “collectibles” to “practicals” (“practicals” included everything from computers

and sporting goods to power drills and athletic socks). All told, eBay estimated that big

companies made up 5% of its sales - roughly $500 million a year.

Internet Case 4-6

Some small sellers did not welcome the corporate merchants and expressed concern about the site

becoming the QVC of the Internet. However, eBay management insisted that the company had

not lost sight of small sellers, and an analysis of transactions showed that eBay auctions were, on

average, bringing higher prices than ever before. The company did concede that it provided

special promotional benefits and discounts to some corporate sellers but noted that

those concessions also drove added buyer traffic to eBay, adding to the legitimacy of the site and

benefiting all sellers. The challenge for eBay would be to find a balance between preserving the

eBay experience that small sellers and seasoned buyers found compelling while growing new

revenue sources.

Offline Businesses

eBay’s offline businesses included Butterfields Auctioneers Corporation and Kruse International,

both of which provided traditional auction services. Butterfields, established in 1865, was the

largest auction house headquartered on the west coast of the United States. With galleries in San

Francisco and Los Angeles and representatives throughout the West and Midwest, it specialized

in fine art, antiques, and collectibles. Kruse International, established in Indiana in 1971, was

one of the world’s leading collector car auction companies.

The PayPal Acquisition

In early July 2002, eBay agreed to acquire Internet-payment provider PayPal, Inc., for $1.4

billion in stock. PayPal, an increasingly popular electronic payment mechanism with a “viral”

effect (the more people who signed up, the more attractive the system became to potential new

users), was widely used to transact business by buyers and sellers on eBay, a situation that, before

the announced merger, created both interdependency and rivalry between the two businesses.

eBay had attempted to build its own electronic–payment service, Billpoint, but PayPal’s earlier

Internet Case 4-7

entry into the market and superior technology created entry barriers that eBay found difficult to

overcome. (Of electronic payments that occurred among eBay users, 70% were handled by

PayPal.) eBay planned to shut down Billpoint when the acquisition was completed. Industry

analysts noted that the acquisition made strategic sense for eBay, giving it a chance to capture

payment fees on top of the 7% - 8% of total merchandise sales it collected from sellers.

Although the biggest chunk of PayPal’s business (67%) came from eBay users, PayPal was also

used in thousands of other transactions, including person-to-person money transfers, and was

accepted at many e-commerce web sites, including pornography sites and small online businesses

that did not accept credit cards directly. Highly popular among online casinos (estimated to

account for 10% - 15% of the company’s revenue in 2003), PayPal would no longer facilitate

gambling transaction once the acquisition was complete because of the murky legal and

regulatory issues eBay believed were involved.

Site Operations and Technology

The eBay site operated on an internally developed software platform that comprised a scalable

user interface and transaction processing system that supported the trading cycle, including e-mail

notifications and confirmations, and sent daily status updates to active buyers and sellers. The

system also stored registration, billing, and credit card information for traders who used an open

account balance. Although the company used multiple, redundant host sites and emergency

power backup, its systems were vulnerable to damage or interruption resulting from weather,

hardware/software problems, and telecommunication failures. Systems were also vulnerable to

break-ins, sabotage, and intentional acts of violence. eBay constantly added to its infrastructure

(hardware, software, engineers, and support staff) to meet the demands of exponential growth.

Internet Case 4-8

 Marketing

eBay used market penetration and product and market development to support aggressive growth.

To build brand awareness and interest, the company relied on word of mouth, public relations,

and participation in trade shows and other events. To attract new users, eBay made strategic

purchases of online advertising, and it engaged in more traditional promotional activities,

including radio, television, and print media. To retain existing users and increase their online

activity, eBay emphasized effective merchandising of users’ product offerings, new features, and

communication via direct messaging. The New York Times monthly analysis of web site hits that

appeared in the newspaper’s business section on September 9, 2002, provides insight into eBay’s

popularity and market share:

Web Sites/Retail

At Home At Work

Property Visitors Property Visitors

1. eBay.com 24.3 1. eBay.com 11.1

2. Amazon.com sites 21.6 2. Amazon.com sites 11.0

3. Yahoo.com Shopping 17.5 3. Yahoo.com Shopping 8.9

4. AmericanGreetings.com 10.5 4. AmericanGreetings.com 4.6

5. ColumbiaHouse.com 6.7 5. Dell.com 4.0

Finance

Internet Case 4-9

eBay’s net revenue from both online and offline activities grew from $41.37 million for fiscal

1997 to $748.82 million for fiscal 2001, a five-year revenue growth significantly higher that the

industry average. The successive year-over-year growth was primarily the result of increased

online auction transaction activity, reflected in the growth of the number of registered users (42.4

million at the end of 2001), listings (423.1 million for 2001), and gross merchandise sales ($9.3

billion for 2001), but it was also fueled by acquisitions. The company had taken advantage of its

economies of scale to drive cost of sales from 26% in 1999 to 18% in 2001. Although sales and

marketing had increased on an absolute basis, as a percentage of sales, those below-the-line costs

had decreased for 43% of sales in 1999 to 34% in 2001. Product development and G&A costs

had followed a similar pattern. eBay was less leveraged and more profitable than industry

competitors. Cash provided by operations in 2001 was $252.1 million. (Note: Complete annual

and quarterly SEC filings are available via the FreeEdgar site, www.freeedgar.com, the

company’s own site, www.ebay.com, and www.wsj.com.)

Internet Fraud and Negative Publicity

Laws regarding liability were still evolving and remained vague; however, because of the

growing popularity of the Internet and online services, many potential new laws that would

address issues from taxation to privacy, freedom of expression, pricing, fraud, and intellectual

property rights were being debated in 2003 at both the state and federal levels. Several states had

proposed laws that would limit the ways in which personal information was collected and

provided to third parties. Although the company provided only the platform for exchange, it had

still been the subject of suits by individuals who believed they had been defrauded on the eBay

site. Because it was unable to prevent fraudulent activity on its site, eBay could face potential

liability for misuse of its site by users. Negative publicity from deceptive sellers could also harm

Internet Case 4-10

the company. Concerns about fraud could serve as a damper on eBay’s rapid growth via new

user acquisition. Owning PayPal would open eBay up to new risks, including payment fraud.

Competition

eBay’s competitive space was characterized by rapidly changing technology, evolving industry

standards, frequent new service and product announcements and enhancements, and changing

customer demands. The company encountered aggressive competition from numerous sources,

including online and offline retailers, distributors, liquidators, auctioneers, catalog and mail-order

companies, and virtually all online and offline commerce venues and participants. Direct

competitors in the auction trading via e-commerce subsegment included Yahoo!, Amazon,

CNET, and uBid. In a surprising move in late May 2002, Yahoo! withdrew from the online

auction business in most European markets after negotiating a 2 ½-year marketing pact with

eBay. Under the terms of the agreement, eBay would advertise throughout Yahoo! in the United

Kingdom, Ireland, France, Germany, Italy, and Spain, and eBay would be featured as the

preferred auction service on Yahoo! in the region. Earlier in the year, eBay had withdrawn from

the market in Japan but still actively pursued other Asian markets. Marketing strategies pursued

by eBay and its online competitors to attract large businesses were likely to shift the power of

buyers/suppliers in the industry.

Internet Case 4-11

Internet Case 4-12