AUCTIONS: For Ebay, one of the market's favourite Web companies, success has bred even higher expectations and has attracted serious rivals in the lucrative internet flea-market sector

In 1997, Mr Pierre Omidyar, a 30-something, French-born computer programmer sporting a ponytail, drove to Silicon Valley's Sand Hill Road to seek venture capital funding for his fledgling online flea market, Ebay.

He had no PowerPoint presentation and no business plan, and did not even carry a laptop. Once one was found, it became clear that his company's computer server was down, meaning there was no active website for him to showcase.

"It wasn't an auspicious start and, frankly, the idea of an online flea market was less than captivating," admits Mr Bob Kagle, a partner at venture capital group Benchmark Capital. But within four weeks, Benchmark had agreed to invest $6.7 million (€7.5 million), valuing Ebay at about $20 million.

That money is still gathering interest in Ebay's bank account in San Jose, for the company has emerged as the dotcom that lived up to the hype.

While its peers burned their start-up cash, Ebay became a phenomenon - a Silicon Valley company that has always made a profit and is the world's most successful internet group, with 38 million customers, making deals at the rate of $9.4 billion a year.

That is just the start, according to Ms Meg Whitman, chief executive since 1998. She has promised that by 2005 revenues will have more than tripled to $3 billion and gross merchandise sales will have reached $35 billion. That would be about the same as for US retailers JC Penney and Kmart, which achieved turnover of some $33 billion and $37 billion respectively last year.

"We are a global trading platform. There are more opportunities than we can chase," Ms Whitman boasts in an interview.

The profit potential is huge. Ebay has almost no cost of goods, no inventories, little marketing costs and no large capital expenditure.

But is Ebay too good to be true? Its profitability does not appear to be financial smoke and mirrors - it has always been cash-flow positive and has more than $1 billion of net cash.

Yet other companies have claimed to have discovered business models that were impossible for competitors to replicate. And Ebay's claim that it can extend its auctions into almost any area smacks of hubris. After all, Enron, the power group that was once the US's seventh-largest company, claimed to be able to make markets in almost any commodity; it is now in bankruptcy protection.

Moreover, Ebay's astonishing valuation (70 times next year's earnings, according to Morgan Stanley) is predicated on continued rapid growth - and there are questions whether that is sustainable. There are already concerns that its core business could be stuttering.

In the quarter to September, US online transaction revenue grew by just 4 per cent quarter-on-quarter, and 54 per cent year-on-year, compared with 7 per cent and 61 per cent in the previous quarter. That business is critical, as domestic revenues account for 84 per cent of sales.

The company has brushed off the lower-than-expected growth, blaming September 11th. But Ebay's turbo-charged stock rating leaves little margin for error, and even bullish analysts, such as Ms Mary Meeker at Morgan Stanley, are concerned growth will continue to slow in the US, Ebay's core market.

The challenges facing Ms Whitman are daunting. To achieve her targets, she must transform Ebay yet again. She must expand the number of different audiences the company serves and move into sectors with higher average selling prices, such as cars. She must increase the range of formats, shifting increasingly from auctions to fixed-price sales - without alienating traditional customers.

She must attract new sellers, particularly big corporations, while raising the amount of revenue from each transaction - all without giving her competitors an opportunity to expand market share. Finally, she must reinforce Ebay's international strengths.

It is a tall order but Ebay could pull it off. Everything depends on pin-point execution by management, and management is one of Ebay's strengths, one of the reasons it has become the dominant force in online auctions.

When Mr Omidyar came knocking on Benchmark's door in 1997, Ebay was in trouble. Though it was growing at 40 per cent a month - without any marketing - and enjoyed 30 per cent margins, it needed professional management. Competition was intense: there were 150 other auction sites, many of them free, unlike Ebay's fee-based service.

"Pierre is a selfless guy," says Benchmark's Mr Kagle. "He knew he needed better-qualified people to run the business. What they were buying was our services and our contacts, not our capital."

Benchmark's investment generated a return of $4.5 billion, probably the greatest profit ever generated in the venture capital industry. But the investment paid off for Ebay too.

"We were critical in bringing Meg and Brian Swette [Ebay's chief operating officer, now head of corporate development]," explains Mr Kagle. "The business model [connecting individual buyers and sellers online and taking a cut of the transaction] was the star of the show. But Meg was the perfect match. Without her, there would have been no initial public offering [IPO], no professional management, no success story."

In fact, Ms Whitman nearly failed to join Ebay. In 1997 she was living in Boston, happy with her new job at toymaker Hasbro running the Mr Potato Head franchise and introducing the Teletubbies to the United States. She had to be approached twice by a headhunter.

In the end, Ms Whitman agreed to visit Ebay. In November 1997, the night before she flew to California, she called up Ebay's website. She was appalled.

"The site was in black and white, and the typeface was a basic Courier. The branding was confused, with Ebay on one page and AuctionWeb on another," she explains. (The company was called Ebay and the website was called AuctionWeb, but both brands appeared on the site.) "I couldn't believe I was flying 3,000 miles for that."

But it was too late to call off the trip. The next day, Mr Omidyar explained Ebay's impressive growth rate, margins and profitability.

"What clinched it was when Pierre said people had met their best friends on Ebay. There was an emotional connection to the site," says Ms Whitman. She brought her family over for the Christmas of 1997 and joined the company on January 2, 1998.

Ms Whitman moved to California in March 1998. She rejected an offer to merge with rival Onsale and instead began to prepare for an IPO. The company had just 35 employees and she began filling senior management positions. She hired auditors and set up the selection process for investment banks to lead the offer, eventually choosing Goldman Sachs.

By September 1998 Ms Whitman, Mr Omidayr and Mr Gary Bengier, Ebay's then chief financial officer, began three weeks of road-shows to investors.

That autumn Ebay enjoyed a sensational IPO - the fifth most successful IPO ever. The shares began trading on Nasdaq on September 24th at $18. By the close of trading they had nearly trebled to $47.

"Our ambition was to become a $1 billion market cap company. Nobody could think bigger than that," says Ms Whitman. Ebay now has a market capitalisation of about $18.7 billion.

Ms Whitman has transformed Ebay from a purely domestic group that held auctions in 300 categories into a global enterprise, operating in 18 countries and offering 16,000 categories.

She has expanded the range of goods sold from mainly collectibles - Beanie Babies dolls accounted for 8 per cent of items sold at the time of the IPO - to include used cars, motorcycles, computers, time-share holiday homes and even golf tee-off times. A Gulfstream corporate jet has been sold on Ebay for $4.9 million.

A motorcycle is sold on Ebay every 18 minutes;a pair of shoes every 35 seconds; a laptop computer every 30 seconds; a book every four seconds; a trading card every three seconds.

Revenues have jumped from $4.5 million in 1997 to an estimated $750 million this year. Ebay claims to control 15 per cent of online commerce in the US.

But the ride has not always been easy. "The worst moment was in June 1999, when the site went down for 22 hours and did not work well for four days," Ms Whitman admits. "During that summer, the question was whether we could scale the business. But what was a weakness - our technology - has become a strength."

Ebay's greatest strength, however, has been the willingness of staff to listen to customers.

"Ebay has always looked after its customers and given them what they want. They have this fantastic feedback loop," says Ms Meeker at Morgan Stanley, who points to Ebay's early introduction of buyer and seller feedback ratings and features such as pictures of goods to be sold.

But if Ms Whitman is to meet her goals, she will have to listen even more closely to customers. The move to sell an increasing number of goods at fixed prices, rather than through auction, has been controversial among some suppliers, as has Ebay's attempt to introduce its own payment system. The strategy of attracting large corporate sellers - such as IBM, now the biggest supplier - has raised fears among smaller, traditional clients.

Such moves risk antagonising the "power sellers", the army of entrepreneurs that have formed the bedrock of Ebay's sellers and make their living trading on the site. They provide the liquidity that makes Ebay the dominant online auctioneer.

"Originally Ebay had a garage sale image but it has become mainstream corporate America," says Mr Kevin Hammond, president and chief executive of Real Legends, a sports memorabilia trader. Like many other sellers, Mr Hammond welcomes the changes because of the new buyers they attract to the site. Others, however, believe corporations will get special treatment from Ebay and destroy its culture.

"Ebay has taken what was a community and now they treat us like a commodity," says Ms Rosalinda Baldwin, editor of Auction Guild, a newsletter about the online auction world.

There is little doubt there is disenchantment within certain parts of Ebay's user community. The question is whether rivals, principally Amazon.com and Yahoo, can take advantage.

Yahoo is particularly aggressive. It makes no secret of going after Ebay and its 23 per cent operating margins. The group claims to be listening harder to its sellers and is undercutting Ebay heavily on price. Yahoo had previously focused on getting as many listings as possible, so it could sell advertising. But there were too many listings of dubious quality, which put off buyers.

"In hindsight, we wish we had started the evolution quicker," says Mr Norm Hullinger, head of auctions at Yahoo. "But we have had big tangible results in recent weeks."

Amazon is also trying to convert its big customer base - 23 million active customer accounts at the end of the third quarter - to the lucrative area of person-to-person trading. In Amazon's case, this is focused on outsiders selling second-hand books at a fixed price for a fee - an area that now accounts for about 17 per cent of its US transactions.

There is a danger that Yahoo and Amazon could start eroding Ebay's liquidity through aggressive pricing. That would hit Ebay's margins, though the company hopes to raise operating margins from the current 25-28 per cent to 30-35 per cent by 2005, says Mr Rajiv Dutta, chief financial officer. That would partly be achieved by raising the amount charged for each transaction or through additional services.

For the moment, however, the competitive threat seems remote. Neither Yahoo nor Amazon can rival the number of buyers on Ebay.

This liquidity is crucial. "I'm not concerned about competitors trying to undercut Ebay on transaction prices," says Ms Meeker. "Buyers want to be where the most sellers are. The economies of scale ensure greater transaction completions and higher average selling prices, so even though the fees might be a bit higher, they are more than compensated."

Mr Paul Canham, who runs IBM's worldwide auctions programme and is Ebay's biggest customer, agrees. Compared with other auction sites, "we feel we are getting better prices at Ebay. This offsets any differential charging."

If Ms Whitman succeeds, she could find that her biggest headache by 2005 is one close to the heart of most remaining dotcoms: cash. With $1 billion already on the balance sheet and projected free cashflow of $1 billion a year by 2005, she will one day have to decide how to spend it.