Venture Capital: Where Mercata led, consumers were unwilling to follow

The "revolution" began appropriately enough on July 4, 1999. That's the day the company launched its "Internet Shoppers' Declaration of Independence," a 59-word statement in which consumers across the world were told to abandon "the old way of shopping" and choose Mercata.

It is safe to say the revolution is now over.

After burning through $89 million, Mercata last week said it would shut down Jan. 31 and lay off more than 100 employees.

Internet companies close every day. But Mercata, along with Freeinternet.com, which filed for bankruptcy last summer after blowing $89 million, is one of the highest profile and most heavily funded local Internet companies to hit the wall.

Why did this high-flier end up in the dot-com graveyard?

Tom Van Horn, the founder and chief executive of Mercata, maintains that the online shopping site was simply a victim of poor market conditions. That, of course, is only part of the story.

Analysts, competitors and outgoing employees say the problems run deeper. The picture they paint is of a company that relied too heavily on deep-pocket investors. It is also of a company that simply missed the mark with its unique group buying strategy, an idea that made sense to analysts and economists but failed with those who matter most: consumers.

Backed by billionaire Paul Allen and others, Mercata turned the e-tailing model on its head. By pooling groups of shoppers over the Internet, the company offered volume discounts on kitchen equipment, computers, luggage and other merchandise from more than 300 manufacturers. An individual could strike a better deal on a JVC stereo system by partnering with like-minded audiophiles through Mercata. At least that's how the model was designed to work.

Many who shopped at Mercata's Web site did score deals, picking up watches, DVD players and digital cameras at bargain prices. Customer reviews on the site glowed, with one enthusiastic shopper saying, "Y'all are amazing. You are making this so easy."

But Jonathan Gaw, an e-commerce analyst at IDC, said Mercata, for the most part, never connected with consumers. Surveys conducted by IDC, Gaw said, found people had difficulty understanding the concept of group buying. "The problem was they were not only trying to build a brand name but they were trying to change consumer behavior," he said.

Mercata acknowledged as much in filings with the Securities and Exchange Commission last year. The company wrote: "The method of aggregating demand to reduce prices on products sold online is new and may not become a popular method of purchasing goods and services."

Despite Web traffic of 996,000 in December 1999, Mercata failed to lure enough customers to support its model.

Michael May, a senior analyst at Jupiter/MediaMetrix, said the company's first foray into e-commerce "was inherently flawed" because it prevented shoppers from buying on impulse. Those who wanted a baby jogger or DVD player, for example, sometimes had to wait seven days for Mercata's so-called PowerBuy to kick in. By that time, shoppers had moved on to another store or online shopping site. Instead of creating a faster, cheaper way to buy products, Mercata actually slowed the buying process.

"As an analyst, Mercata was an incredibly neat idea," said Carrie Johnson, online retail analyst at Forrester Research. "But for a consumer it is not so exciting, and the reason is that the deals were not worth waiting for."

In addition, Mercata could not compete with the Wal-Marts and Targets of the world. No matter how many shoppers showed up for a PowerBuy, the big box retailers still had more leverage, said IDC's Gaw.

Still, Mercata continued to attract interest. Last March, the company raised $40 million in a third round of funding co-led by Amerindo and Europ@Web. It also filed for a $100 million initial public offering that same month. Total financing in the company at that time stood at $89 million. Little did company executives or investors know that the market was about to crater for companies just like Mercata. A spokesman at Amerindo refused to discuss its investment in Mercata. Vulcan Ventures, the investment arm of billionaire Paul Allen, did not return calls.

How a new company, with little or no track record, blows through $89 million in just over two years is a phenomenon of the go-go days of the Internet.

While four of the company's top executives made more than $110,000 a year and Mercata at one time employed as many as 13 vice presidents, most of the money was lost in advertising and other expensive marketing programs.

The company's television advertising campaign -- which won two Telly Awards for its "Down is Good" campaign -- consumed millions of dollars. So did full-page advertisements in the Wall Street Journal and New York Times. Another costly program essentially gave new customers $100 to spend.

Jim Rose, chief executive of MobShop Inc., Mercata's primary competitor, said his company avoided the high burn rate of cash by focusing more on selling its group buying technology to other Web sites. "You look at Mercata spending $90 million and you think that is a boatload of money," said Rose. "But at the time analysts were saying it would take $150 million to $250 million to build a sustainable consumer brand, and that is what they were trying to do."

As a result, Mercata lost $36 million in 1999 on sales of $6.3 million, the last period for which public financial information is available. The company has not filed for bankruptcy.

Linda Perkins, vice president of merchandising at Mercata, said the company was not wasteful in its spending and was successful in most of its endeavors. An 18-year veteran of Costco Wholesale and Price Club, Perkins said it is difficult to say exactly what went wrong. "I suppose everyone could say it was this or that, but I don't think it was necessarily one thing," said Perkins. "Market conditions prevailed and we got caught up in that. The market just changed hard and fast."

P-I reporter John Cook can be reached at 206-448-8075 or johncook@seattle-pi.com. For more information on Seattle-area start-ups or venture capital firms, visit www.seattlep-i.com/venture.