Knowledge@Wharton Strategic Management Research Article

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On January 29, online auctioneer eBay unveiled plans to revamp the fees it charges sellers, reduce fraud and increase the volume of transactions. It's the first move by CEO-elect John Donahoe, who will take over the reins of eBay on March 31 in the wake of long-time CEO Meg Whitman's announcement that she plans to step down.

Donahoe's mission is to reinvigorate a company that remains dominant in online auctions, but is vulnerable to increased competition from large rivals, such as Amazon.com and Google, as well as smaller e-commerce sites like Etsy, which specializes in handmade crafts. EBay is also facing slowing growth. Its fourth quarter product listings -- a measure of the number of goods for sale -- were up just 4% from a year ago and the number of active users on the site is flat.

Experts at Wharton say that eBay isn't in dire straits, but if it wants to increase growth it has to make changes and focus on its core competencies. According to Wharton management professor Raffi Amit, eBay has taken a few strategic detours -- such as its 2005 acquisition of Internet telecommunications company Skype. When eBay acquired Skype, executives said its communications services would be integrated into the company's auction platform. "I never [understood] the Skype deal. I'm never sure I got down the key ideas behind it," says Amit. In 2007, eBay took a $1.4 billion goodwill impairment charge -- an acknowledgement that a particular acquisition didn't generate the value initially expected -- related to the Skype deal.

Wharton marketing professor Eric Bradlow agrees that eBay may have lost some of the focus it had as a startup. "EBay, like any mature firm, needs to understand the value added it provides over the competition.... For eBay, it is brand recognition which gives it higher awareness and higher trust." Adds Kartik Hosanagar, a professor of operations and information management at Wharton, "In some ways, the economics of eBay's business are great. The business model is such that the gross margins are very healthy. EBay's problem is just that it is mature now, and growth has stalled."

Analysts suggest that eBay's business model, which largely relies on charging merchant fees upfront, could use a few tweaks. Marianne Wolk, an analyst with Susquehanna Financial Group, said in a research note that "eBay's business model has been out of sync with the performance-based models popularized by the search economy," which dictates that users pay for performance, such as a lead to complete a sale. Applied to eBay, this approach would mean that eBay should collect more money when a sale is successful.

To remedy the problem, eBay cut listing fees 25% to 30%, but raised the fees it charges when an item is sold. In a speech before 200 North American sellers on January 29,Donahoe said that the new fee structure minimizes the risk for sellers if an item doesn't sell. "Put simply, we will make more of our money when sellers are successful," Donahoe stated.

Wharton faculty say Donahoe will have to do more than change fees for auction listings: He will need to push eBay to be more innovative. "EBay has to be more aggressive and think about strategic planning five to 10 years down the line," says David Hsu, a management professor at Wharton. "You can't transform overnight, but you do have to be able to assess the future better than others."

One point on Donahoe's side is timing. According to Hsu, Donahoe takes over as CEO at an opportune moment. Since Donahoe is a company insider, he already has the trust of employees. Add to that the stagnant growth the company is experiencing, and the result is a mandate for Donahoe to make changes. "He knows the business and can experiment," says Hsu. Indeed, Donahoe seems prepared to take some chances, noting on eBay's fourth quarter conference call that he will "aggressively change our product, our customer approach and our business model."

Here's what should be on Donahoe's to-do list, according to Wharton faculty.

Perfect the Basics

On his earnings conference call, Donahoe outlined a few areas to address -- including fraud, the difficulties some have in navigating through eBay and the need for better search tools. All of these problems are being addressed in phases throughout 2008, he noted. "We're going to get very aggressive about making eBay easier and safer to use. The Net has evolved dramatically in recent years. Buyers have become accustomed to streamlined purchasing experiences that put a premium on speed, convenience and reliability. While we have made strides in these areas, I am clear that we need to do much more."

Analysts say that eBay needs to better integrate its auctions with the fixed-price shopping convenience offered at sites like Amazon. EBay already offers a hybrid auction/fixed price approach with its "buy it now" feature, and that could give the company an edge. The company should keep the excitement of winning an auction while providing the easy convenience of buying at a set price, says Bradlow. "This hybrid model is clever in that it allows customers to have it their way," he notes. 

Donahoe himself has suggested that "eBay's next wave of growth is going to come from weaving the strengths of auctions with our fixed price in a uniquely eBay way. Auctions attract enormous value, selection and fun to eBay but for many sellers and buyers and for many products, auctions are just not the optimal format. So what we need to do is marry the value selection fun created by auctions with the convenience and opportunity inherent in fixed price." EBay, Donahoe added, is also reworking its search abilities, making it easier to add pictures to listings, and is changing its web site to improve the company's merchant rating system.

These planned changes are good steps, but as Bradlow notes, because "people have an expectation that Internet retailers will be more innovative," eBay will be held to a higher standard than other companies, and will have to not just meet, but "exceed expectations."

Hosanagar echoes Bradlow's point about innovation being a core competency. EBay's challenge is to launch innovative new services -- either through acquisitions or experimentation within the company. "[Innovation] is always a challenge for mature firms. Some firms have successfully driven growth by innovation, like Apple, or acquisition, like Cisco. EBay has had mixed results with acquisitions. My take is that eBay has done a poor job of identifying synergistic opportunities. Similarly, although eBay has a research group, it has not been able to drive much growth by internal innovation." EBay, Hsu adds, has to get that "spark the company had in the early days."

Pick a Strategic Path

Amit suggests that another key chore for Donahoe is to outline a strategic plan. EBay has two alternatives typically faced by companies that grow fast and then mature. "It can either have total focus on the one thing that it does best and penetrate new markets. Or ... it can take its core competencies and expand into related businesses where its auctions are a complement."

If eBay were to focus on taking its core auction business to new markets, two obvious choices would be China and India, Amit says. Ebay has already ventured into China -- with mixed results. In 2003, eBay acquired Chinese company Eachnet to launch its China operation. However, in 2006, eBay put its Chinese operation into a joint venture with Tom Online, a local wireless Internet company. Analysts viewed the move as a retreat for eBay.

What's different this time? Amit says that credit card use is increasing in China and India, thereby making eBay's business model, which depends on electronic payment systems, more feasible. In that sense, eBay's first effort in China was too early, says Amit.There will be challenges in both China and India, but eBay could sustain growth for years in those markets.

Hosanagar agrees that eBay has to expand abroad, but acknowledges such moves are tricky. "EBay must figure out ways to have an impact elsewhere like it did in the United States. While eBay made significant investments in both China and India, both efforts were largely unsuccessful," he says, adding that trust is a major impediment to eBay's business in countries like India and China. But those issues could be overcome if eBay partners with local banks, insurance firms and even competitors to establish best practices. "EBay needs to do more in these countries to develop the market itself."

The other strategic approach sees eBay expanding into new, but auction-related, businesses through acquisition, says Amit. The auction giant already has a blueprint for this strategy with its acquisition of PayPal and Shopping.com. Using this approach, eBay could emulate companies like Cisco Systems and Oracle, which have completed dozens of acquisitions. The acquisition route could be risky, however, if eBay tries to diversify into unrelated businesses.

According to Hsu, another risk to any acquisition strategy is the drain on management time. If eBay were to start making larger acquisitions, it would require upper management attention to integration plans. A better route may be to focus on smaller deals. "The acquisition route is tough," says Hsu. "The question [eBay will have to face] is whether it wants to devote CEO time to integration or make smaller bets. It's best to go the targeted route."

Hosanagar suggests that before Donahoe focuses on any specific strategic plan, he needs to figure out what the company does best and then thread its existing businesses together better. "EBay must articulate a clear long-term positioning and core competence, and use that to guide its acquisition strategy." 

Can EBay Restore Past Glory?

Experts at Wharton say Donahoe will have his challenges managing eBay and boosting growth, but the company has resources at its disposal. Perhaps the biggest asset eBay has -- aside from $4.9 billion in cash and short-term investments as of December 31 -- is its community, says Amit. "Donahoe has a lot to work out, but he is sitting on enormous valuable assets such as community and reputation."

EBay can use the social nature of its site to create new tools that could improve the rate of purchases, he adds. "In many ways, the eBay community is a social network." Utilizing social networking and pursuing related businesses to complement auctions eBay could gain more "wallet share" from its existing customers.

Meanwhile, eBay's business model isn't broken. For the year ending December 31, 2007, eBay reported net income of $348 million on revenues of $7.67 billion. What is different, however, is that eBay now has more competition than ever. On Amazon's fourth quarter conference call, chief financial officer Thomas Szkutak said Amazon has been successful attracting outside merchants to use the e-commerce company's platform. Amazon's third-party merchant services resemble eBay's, with features such as seller ratings. The big difference is that Amazon's merchants sell at a fixed price while eBay conducts auctions. "Our seller business globally is very strong," Szkutak noted during the call. "We are continuing to try to work on that experience for sellers to make it even better. Certainly our goal is to have sellers increase their sales on our platform and so we continue to do a number of different things to make it easier for them" to accomplish that.

Google, which has its own payment system called Checkout to compete with eBay's PayPal, is also a threat, according to Hosanagar. But eBay has an excellent brand and can compete with its rivals. "EBay starts as a favorite," he says. "This is eBay's game to lose."

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