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Choose Your Medicine

Three Web startups are trying to grab a piece of the online drugstore market.

Each has a different prescription for technology leadership.

In this story learn about:

How companies offering the same products look to information technology to differentiate themselves Challenges faced by Web sites selling pharmaceuticals Online Pharmacies On Speed Talk about moving at Web speed: Online pharmacy Soma.com is joining forces with brick-and-mortar retail drugstore giant CVS Corp., while rival startup Drugstore.com Inc. has filed for an IPO.

CVS announced plans to buy Soma on May 17; the US$ 30 million deal is expected to be completed in June. Soma, which went live in January, was an attractive acquisition target because it had already built its own state-of-the-art, automated fulfilment centre (Drugstore.com outsources fulfilment). For CVS, the deal gives it a way to jump-start its e-commerce strategy; Soma, meanwhile, gets to draw on the chain of 4,100 CVS brick-and-mortar stores, plus its marketing strength, product selection, and health insurer relationships.

Two days after Soma's big deal and less than three months after going live, Drugstore.com filed its registration statement with the Securities and Exchange Commission. In the SEC documents, Drugstore.com revealed that as of April 4, it has a total net loss of nearly US$ 18 million versus sales of US$ 652,000. As with most Web startups, Drugstore.com expects those losses to continue into the foreseeable future, as it spends serious bucks to establish its brand and attract new customers.

The online pharmacy market is like a chess game, where the challenge is to outthink opponents.

From a sleek black tower on the east side of Seattle, a Web startup is trying to change how Americans care for something that's even dearer to them than their wallets: their health. Across Lake Washington, in a nondescript Redmond office park, another Web startup is working feverishly toward that same goal.

About 700 miles south as the crow flies, in a long building near South San Francisco's marina, a third startup is hot on the heels of the first two.

These three startups - Soma.com, drugstore.com Inc. and PlanetRx Inc. - opened Web-based drugstores during the first quarter of this year. The lure of the drug market is easy to understand: Americans bought an estimated US$ 102 billion in prescription drugs last year from old-fashioned corner drugstores, drugstore chains, supermarkets, mass retailers and mail-order firms. At independent and chain drugstores, they spent another US$ 104 billion on nonprescription medicines, vitamins, health, beauty and other products. That dwarfs the US$ 13 billion Americans spent last year in brick-and-mortar bookstores, the market space that Amazon.com Inc. has turned on its head.

Like Amazon.com, these three startups are racing to get established before more brick-and-mortar drugstore giants wake up to the Web. But the online drug market won't be as easy to conquer as the book market. These startups sell complex products in a complex industry that's regulated state by state. They are scrambling to strike up partnerships with the same health insurance and prescription plans that pay for most consumers' prescription drugs (and that are sometimes leery of new delivery channels or may even see them as competition). They face the same core challenge of getting consumers to believe that buying everything from aspirin to Zoloft over the Web is more convenient than standing in line at the drugstore or supermarket and that asking a pharmacist an embarrassing question via e-mail is more confidential than asking that question over the counter. Despite their similarities, however, these startups have made some sharply different choices about what it takes to be a successful e-business.

This story will look at these companies' rationales for their choice of technology leadership. Of course, the choice of technology leader is not the only thing that could give one of these companies a competitive edge. There are other differences between their offerings: Drugstore.com touts its broad selection of health and beauty products and its detailed information on both over-the-counter and prescription medicines; Soma.com is the only one of the three to dispense class 2 pharmaceuticals (a class of drugs that have a medical use but can be addictive or abused, such as the narcotic painkiller Percocet); PlanetRx prides itself on its original content, such as its extensive online health library on topics from acne to warts, including advice, treatment options and links to related products. But no company can compete in this space for long if its IT infrastructure can't support a convenient, customised, secure and confidential shopping experience with rock-solid reliable distribution and customer service. It's not a tragedy if Auntie May gets the wrong colour sweater for her birthday or gets that cookbook the day after Christmas, but it could be one if she gets the wrong blood pressure pills or her refill is late.

The Pharmacy Comes First: Soma.com

Soma.com's 30-year-old CEO, Tom Pigott, founded the company in December 1997.

While his family's Seattle business roots lie in traditional industry (his father, Charles Pigott, was the former chairman of Paccar Inc., a US$ 6 billion truck manufacturer), by late 1997 his hometown, where Amazon.com sits across the lake from Microsoft Corp., had clearly become a Web hotbed. There was no shortage of local Web development firms that could build an e-commerce site to Soma.com's specifications; Pigott tapped two - Tim Girvin Design Inc. and Accelerated Inc. - to design and implement the site, and picked another local firm, Exodus Communications Inc., to host it. But Pigott thought it was essential for Soma.com to run its pharmacy warehouse and fulfilment centre so that it could guarantee rapid and reliable distribution. "Our focus has always been on the pharmacy," says Pigott. "We happen to use the Internet as our primary means of distribution and communication." Soma.com hired executives who had experience running mail-order and retail pharmacies. The company set up its warehouse and fulfilment centre in West Chester, Ohio, near five pharmacy schools and three overnight air hubs. At this writing, Soma.com claims to have arrangements with insurance and prescription plans to cover more insured Americans than its competitors do (120 million compared with 85 million at drugstore.com and 80 million at PlanetRx).

Last December, about a month before the site launched, Soma.com hired Tim Fletcher as director of Internet business strategy. Fletcher, formerly a developer and a business development executive at a Seattle interactive agency, was charged with building an in-house Web operations team and helping define the site's direction. The Web operations team would take site development in-house. Fletcher sees the online pharmacy market as a chess game, where the challenge is to outthink opponents. "We have access to the same sorts of technology that our competitors do," Fletcher says. "[The difference] is how we chose to use them and deploy them and combine them with business relationships." Soma.com has an IT manager who oversees the LAN and the WAN. But Pigott and Fletcher say the company doesn't need a CIO or a CTO. "We're not really a technology company in the sense that we're marketing or selling or retailing our technology," Fletcher says. "Technology is merely an enabler for our business philosophy, which is about great customer service [and] about the consultative value of pharmacists." Soma.com was the first of the three to launch. While not critical of the Web shops that designed the first site, company officials admit that some elements of the site needed tweaking. For example, the site's emphasis on security made it difficult for customers to switch from ordering prescription drugs to ordering over-the-counter medicines. Integration between the Web site and back-end systems needed to be improved so that customers could see their order histories. The site also did not show the prices for any prescription drugs (drugstore.com did show drug prices when it launched). This spring, Fletcher says, Soma.com developers added prices for 200 of the most popular drugs to the site and addressed the ordering and integration issues; they plan to expand pricing availability sometime in the future.

CIO from Square One: Drugstore.com

Like Soma.com, drugstore.com wants to be the market leader. Yet to do that, the company took a different strategic tack than Soma.com did. Instead of building pharmacy fulfilment capability first and hiring an in-house technology leader later, drugstore.com hired its technology leader first and then found a partner to handle pharmacy fulfilment. Drugstore.com has its own pharmacists on staff, but partner RxAmerica fulfils and ships the site's prescription drug orders nationwide out of RxAmerica's high-volume mail-service facility in Fort Worth, Texas. Walsh Distribution, which has a warehouse in Texarkana, Texas, fulfils and ships over-the-counter products. "If you're trying to move quickly, you can't necessarily do everything all at once and excel at them," says Peter Neupert, drugstore.com's president and CEO. "You have to look at the types of things that only we could do and the types of things that others can help us do." Why the priority on building in-house IS talent from the start? Jed Smith, drugstore.com's founder, offers an analogy that one of his Harvard Business School professors used to make: The factory was the breakthrough of the Industrial Age; companies that built efficient factories had a competitive advantage. Today software is analogous to the factory; companies that build efficient code will have the competitive advantage. That's why drugstore.com searched for a CIO at the same time it searched for a CEO. Last August it hired Kal Raman, former CIO at NationsRent, a US$ 300 million heavy-equipment rental and retail company, as CIO and vice president. "Having a leader like Kal able to build a world-class [IT] team quickly and guide them effectively is a rare and unique talent," Smith says. (Hiring Raman, formerly director of international systems at Wal-Mart Stores Inc.'s international division, later drew some heat to drugstore.com: The company and Amazon.com were the target of a Wal-Mart lawsuit last year, alleging that they hired away Wal-Mart IS employees to steal trade secrets. The companies settled out of court in April.) Raman had never before built an e-commerce site. But given his background at global retailers like Wal-Mart and Blockbuster Entertainment, where he was senior director of information systems, Raman says he knew how to design a system for security, scalability, reliability and flexibility. Here's how he describes drugstore.com's architecture: At the front end, there's a Web farm (hosted by Exodus Communications), which is separated from the data stores with a firewall; the transaction processes, running on an operations server, are separated from the data stores by another firewall; on the back end, the orders get sent to the distribution centre, which is separated by yet another firewall. "If the whole world goes down on the back end, we can do business in the front end," Raman says. "If the whole world goes down in the front end, I can ship product out the back end." A flood of publicity heralded the site's launch, given the high profiles of drugstore.com's executive team and Silicon Valley venture capital firm - Kleiner Perkins Caufield and Byer, the same firm behind Netscape Communications Corp. and Amazon.com. Then, on launch day, drugstore.com announced that Amazon.com was going to become a strategic partner and a significant minority shareholder. Opening-day traffic levels were three times higher than expected; some users had trouble getting into the site because of the authentication at the front end. "We had to clearly hurry to get that thing opened wide enough in a secure fashion so that we could still be in business," Raman says. "It took us probably three hours, and since then we have not had an issue." He says he has also seen the payoff from all the development time spent figuring out what features the site might need in the future and designing in the flexibility to offer those features. For example, when back orders for over-the-counter products climbed by one-tenth of a percent in five days, drugstore.com strategists decided that the Web site needed to be able to show customers whether a product was in stock. Raman's team was able to reveal that information on the site in just one day. "So many companies, they just struggle for months to show that," Raman says.

CTO for Scalability and Security: PlanetRX PlanetRx was the last of the three sites to launch. It built its site with an in-house team and secured its pharmacy license in 50 states before it launched.

Given CEO Bill Razzouk's 13-year tenure at Federal Express Corp., it is perhaps no surprise that PlanetRx built its warehouse and fulfilment operations in Memphis and that it runs them itself. "We wanted to control the consumer experience from A to Z," says Stephanie Schear, PlanetRx's vice president of business development and cofounder.

PlanetRx's CTO, James Chong, says he was hired in January after the company had already begun a substantial amount of work on its site. Chong was brought on board because the company believed having someone with proven experience at building a scalable, secure e-commerce site would be key to its success. Chong, an 11-year veteran of Charles Schwab and Co., fit the bill; his most recent post at the brokerage firm was vice president of architecture and planning, where he was the brains behind the architecture of Schwab.com, a site designed to handle more than 4 million transactions an hour.

When Chong came on board, his first task was to evaluate the company's portfolio of technologies and implementations and make sure that they offered the reliability, security and scalability that an online drugstore would demand. He shied away from using Active Server Pages, Microsoft's Windows NT-based Web technology, because he does not believe that it is scalable. While the site now runs primarily on NT, Chong plans to migrate to Unix, since he believes Unix is more scalable and robust. To generate dynamic pages, he used Javascript. He also did a lot of work on the back-end warehouse application to make sure that when a customer places an order online it ripples through PlanetRx's transaction infrastructure, all the way through printing invoices and packing slips. Like drugstore.com's Raman, Chong says the real competitive edge of an e-commerce site is on the back end. "You can put a feature or products onto a Web site," Chong says, "and you can almost bet that within a week or two somebody is going to copy that." Chong says the site has multiple layers of system security as well as physical security. Like Soma.com and drugstore.com, PlanetRx outsources site hosting. But it is building its own data centre in Memphis, and Chong plans to bring hosting back in-house. "It is extremely difficult for anybody to provide 24/7 and a scalable solution if the company doesn't own its infrastructure," he says. Beyond that, Chong is closemouthed on details of PlanetRx's system architecture, except to say that he doesn't want to be compared with his competitors. "We're very different underneath from a system point of view," he says.

PlanetRx, backed by the high-profile VC firms Benchmark Capital and Sequoia Capital, also received a lot of prelaunch attention. And on opening day, it received far more traffic than expected, according to Schear. Some people did have trouble getting into the site, but PlanetRx added servers and was able to handle the traffic. "We handled our first-day volume with aplomb," Chong says.

Now that these startups are up and running, albeit with a few bumps along the way, which of them has the right idea about what will give it a competitive edge? Is it Soma.com with its emphasis on the pharmacy part of the equation? Drugstore.com with Raman's retail expertise? Or PlanetRx with Chong's experience building an e-commerce site that can serve massive numbers of customers? Time will tell. But as David Marshak, senior vice president of e-business strategies and solutions at Patricia Seybold Group Inc. in Boston notes, building a banner e-business requires more than one strength.

Amazon.com, for example, has a strong brand, a wide variety of merchandise, easy-to-use ordering and responsive customer service. "They're all important," Marshak says. "The reason they're successful is that they're on top of all them." Three Drug Startups at a Glance Soma.com URL: www.soma.com Location: Seattle Launch: Jan. 15, 1999 Number of employees: 90 CEO: Tom Pigott, son of Charles Pigott, former chairman of Paccar Inc., a US$ 6 billion truck manufacturer Director of Internet Strategy: Tim Fletcher Financing: Will not reveal identities of private investors or amount invested Number of insured lives covered: 120 million Drugstore.com Inc.

URL: www.drugstore.com

Location: Redmond, Wash.

Launch: Feb. 25, 1999

Number of employees: 170

CEO: Peter Neupert, former vice president of news and publishing at Microsoft Corp.'s Interactive Media Group CIO: Kal Raman, former CIO of NationsRent Inc.

Financing: Raised more than US$ 60 million; funded by Amazon.com Inc., Kleiner Perkins Caufield and Byer, Maveron LLC and Liberty Media Number of insured lives covered: 85 million PlanetRx Inc.

URL: www.planetrx.com

Location: South San Francisco, Calif.

Launch: March 18, 1999

Number of employees: 135-plus

CEO: Bill Razzouk, former executive vice president of worldwide customer operations at Federal Express Corp.

CTO: James Chong, former vice president of architecture and planning at Charles Schwab and Co.

Financing: Raised more than US$ 32 million; first-round investors were Benchmark Capital and Sequoia Capital; later investors include Amerindo, Bowman Capital, Capital Research, E-Trade, LMVH Group, Hambrecht & Quist, Phoenix Partners and TTC Ventures, a division of the Thomson Corp.

Number of insured lives covered: More than 80 million Who Needs a CIO Anyway? Arguments for both cases Just how important is it to have a CIO or CTO at a Web startup? Alyse Terhune, a research director at GartnerGroup Inc. in Stamford, Conn., believes a CIO or CTO is just as important at a Web startup as it is at a more established company. "You need someone to deal with your technology strategy, whether it's someone with the title CIO or CTO," Terhune says. "You can outsource the grunt work, but you should never really outsource the strategy." But Ron Shevlin, analyst at Forrester Research Inc. in Cambridge, Mass., thinks that a CIO at a Web startup is not a necessity. Traditionally, CIOs are technologists, Shevlin says; they're good at managing big IT groups and at supporting internal business processes in companies where executives don't have a clue about the importance of technology. Internet startups, on the other hand, understand that their business is the computer. "They don't need another senior executive to manage the group of developers," says Shevlin. "They don't need another executive to get in the middle of that." Perhaps watching these drug startups execute over the coming year will help give an answer.

Senior Writer Sari Kalin can be reached at skalin@cio.com.

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