Smith's turns to on-line retailing

WH SMITH'S announcement yesterday that it is paying pounds 9.4m for The Internet Bookshop, a three-year-old on-line bookseller, is just the latest example of major retailers starting to take this new medium seriously.

A couple of weeks ago The Gap announced that it was to start selling its preppy causal clothes on an Internet web site for the first time. That followed a decision by Sainsbury's to extend its home delivery service - with an Internet ordering option - to 30 stores.

But books, along with CDs, are seen as one of the key sectors which could see rapid growth on-line. For customers who know what they want, buying books and music over the Internet can be cheaper and more convenient, as well as providing access to a far greater range than even the largest conventional stores can ever offer.

For example the Internet Bookshop's web site, which trades under the name bookshop.co.uk, offers customers 1.4m titles and it can cut the price of popular titles by up to 40 per cent.

"The electronic commerce market is currently relatively small but we expect it to develop significantly over the next few years," said Richard Handover, WH Smith's chief executive yesterday. "The WH Smith brand has good potential to trade competitively in this market particularly as the customer base broadens.

Industry figures back up his confidence. The UK on-line market was worth only pounds 200m last year but is predicted to grow to pounds 800m by 2000. Books and music are the fourth most popular product type in on-line retailing after computer products, travel and entertainment. On-line book sales are said to be running at only around pounds 20m in the UK at the moment but are doubling every year. "Books are one of the hottest items on the web," said Ross Beadle the Internet Bookshop's marketing director.

There has certainly been a rush of activity in Internet bookselling in recent months. In April Amazon.com, the largest Internet bookseller, paid $55m for three Internet businesses including bookpages.co.uk, to give it access to the UK market. Last October Dillons and Hammicks, two UK chains, announced plans for a joint venture in on-line bookselling. This followed a move by Waterstone's to increase the number of books on its web site from 90,000 to over a million to compete with Amazon which claims to stock over 2.5m titles.

It is clear that the traditional book retailers such as Smith's and Waterstones's realise that the "virtual retailer's" such as Amazon, offer a significant competitive threat as they have lower costs because they do not have expensive store portfolios.

So while going on-line themselves might risk cannibalising sales in their shops, the traditional retailers feel having an on-line presence is the best form of protection.

City analysts took this view yesterday saying Smith's move would help it defend itself against Amazon. After selling Waterstone's a couple of months ago, Smith's only had a tiny Internet presence through its WH Smith Retail web site. "They probably felt a little exposed not being in that market so they've done the right thing getting back into it," said Iain McDonald at Charterhouse Tilney.

Richard Perks at Verdict, the retail consultants, was equally supportive. "Books are products that lend themselves to the internet - you don't actually need to see the product to know what it is you are buying. "The question is whether the Internet can offer something that is substantially better than existing book shops in terms of choice and price and that is developing on an almost daily basis."

He added that the expansion of the Internet book retailing market would increase the prospect of an on-line price war that could spread to high street stores. Traditional operators like Smith's and Waterstone's are already under threat from US competitors such as Borders, which acquired the Books etc chain last year.

While Smith's deal might make strategic sense it is paying 265p per share for a business whose shares were trading at 85p last Friday. It is also paying various option holders an additional pounds 600,000. The company admits it does not expect to make "significant financial returns" from this area in the short term.

Bookshop.co.uk recorded losses of pounds 406,000 last year on sales of pounds 2.2m. It was set up in 1992 by Darryl Mattocks as an information technology consultancy before becoming bookshop.co. uk in 1994. The same year it raised pounds 1m after joining OFEX, the market for unlisted companies. Of its pounds 213,000 assets, pounds 212,000 is cash.

Mr Mattocks, who resigned from the board a couple of months ago to pursue other interests, still holds around a third of the shares and so will net pounds 3m from the deal.

The existing executive management team will stay on to develop the business. It plans to continue its pricing policy which sees the largest discounts offered to first time buyers and targeted at the most popular titles. Discounts are then gradually reduced on subsequent purchases, though the company says this does not deter customers as more than half its sales are repeat business.

On-line sales by product

FIGURES IN $M

1997 1998 2001

PC hardware & software $863 $1,616 $3,766

Travel $654 $1,523 $7,443

Entertainment $298 $591 $2,678

Books & music $156 $288 $1,084

Gifts, flowers & greetings $149 $264 $802

Clothing & footwear $92 $157 $514

Other $232 $389 $1,100

TOTAL: $2,444 $4,828 $17,387

Source: Forrester Research Inc