It seemed like a boffo idea to the brass at the Internet auction site eBay: By referring losing bidders to similar auctions by other eBay sellers, they’d keep bidders coming back. Within minutes of the program’s debut in early June, though, all hell broke loose.

Hundreds of angry sellers jammed eBay’s online discussion boards, furious that their bidders were being siphoned away. One veteran seller of stamps and postcards, Bob Miller, auctioned a rare eBay jacket as an excuse to post a long screed slamming "eBay’s new policy of screwing the folks who built them."

Even among the 7 million ongoing auctions, this one quickly caught the attention of CEO Margaret Whitman and founder Pierre Omidyar. Within a week, they met with Miller in eBay’s suburban Salt Lake City office near Miller’s home. As they listened for 45 minutes, Whitman took four pages of notes. Two days later, they promised to switch course.

E-mails would first recommend the same seller’s other auctions, or the seller could simply opt out. "No other large corporation listens nearly as well as they do," says Miller, who’s now happily running several thousand auctions on eBay.

Meet the People’s Company. Like a democracy, it can be a noisy and unruly place, where citizens sometimes think the folks in charge are numbskulls. But the people’s passion prevails at eBay because the people are firmly in charge. Its customers—the 38 million buyers and sellers who trade on its site—wield the kind of influence over the online auction site that most consumers and businesses could never dream of exerting on conventional companies.

Oh, sure, eBay has a delicious business model that doesn’t require carrying any inventory. And, yes, it’s growing like a weed and minting juicy profits because bargain hunters, in good times and bad, flock to the auction site. But the real secret of eBay’s unlikely success is this: It’s a master at harnessing the awesome power of the Net—not just to let its customers sound off directly in the ears of the big brass, but to track their every movement so new products and services are tailored to just what customers want.

One month in late 1998, for instance, eBay managers noticed an uptick in listings in various miscellaneous categories, such as die-cast cars—suddenly people were selling real cars. Now, eBay’s the country’s biggest car dealer, with $1 billion in sales of cars and car parts this year. In January, shortly after an eBay seller suggested speeding up auctions for impatient bidders, eBay debuted a ‘buy it now’ feature that lets bidders end an auction at a set price. Now, 40% of listings use it, attracting more mainstream buyers and helping close auctions nearly a day faster on average than a year ago.

All in one
In essence, customers are eBay’s de facto product-development team, sales and marketing force, merchandising department, and security detail—all rolled into one. It’s not just that they have catapulted eBay, in just three short years, from a funky little online garage sale full of attic trash into a global marketplace for almost anything, from a $1 baseball card to a $4.9 million Gulfstream jet. eBay’s customers also take it upon themselves to tell the world about eBay through word of mouth. They crowd eBay’s online discussion boards, posting 100,000 messages a week to share tips, point out glitches, and lobby for changes. eBay’s customers even police the site by rating each other, keeping fraud minimal. By using the Net to tap into the talent and imagination of its customers, eBay has multiplied the brainpower of its executives by millions.

The success of this let-’em-loose-and-listen strategy holds some potent lessons for Corporate America. By staying in close touch with customers, eBay can reinvent itself every day, since it knows precisely what its clientele wants. The trick is to keep up with what buyers and sellers want. "We start from the principle that if there’s noise, you better listen," says COO Brian Swette.

And, because it set a firm corporate goal from the start—to create "global economic democracy"—it has managed to maintain focus even while growing at a crazy clip. First-time eBay buyers are often shocked at the intensely personal service they get from eBay merchants, from handwritten thank-you notes to free shipping. It’s an example of how building a strong brand depends more on understanding that each and every transaction can create a personal, one-on-one relationship that will endure. Says eBay board member Howard Schultz, CEO of Starbucks: "The imprinting of the eBay brand was not based on 30-second ads, but the relationship with the users."

That’s why neither September 11 nor the recession has put a pall on eBay’s prospects. Despite losing about $5 million in revenues from a drop in activity following the terror attacks, eBay beat third-quarter estimates. Sales rose 71%, to $194.4 million, surpassing expectations by 3%. It earned an $18 million profit, 15% above analysts’ forecasts. eBay even raised its fourth-quarter sales forecast by 5%, to $200 million or more. Analysts now expect 2001 sales to jump at least 70%, to $736 million. Next year looks just as promising. Analysts figure sales will rise 40%, to $1 billion, and profit will be up 56%, to $150 million. Rivals are in awe: "These guys have done a killer job," admits Amazon.com CFO Warren Jenson.

Smarts, moxie
Now, eBay appears poised to buck the seemingly gloomy holiday season for almost every retailer, online and off. That’s largely thanks to the smarts and the moxie of its customers, who—unlike big retailers—can switch gears instantly on what they sell or buy and at what price. As the economy worsens, more and more corporations, from IBM to Walt Disney to Sears Roebuck, are turning to eBay as a place to unload mounting inventory. "The mix of products on the site changes by the minute as our highly entrepreneurial community of users adapts their own buying and selling strategies to trends in the economy," says Whitman.

For all its nonstop success, though, eBay faces a lot of challenges. Its $60 stock price represents a nosebleed 2002 price-to-earnings ratio of 82, more than double Microsoft’s premium ratio of 31. The tiniest slip—or even, say, a few more anthrax-laden packages—could whack billions off its value overnight and limit the expansion opportunities that have in turn buoyed the stock.

Indeed, eBay is increasingly a victim of its own success. As Whitman moves to make eBay more of a clean, well-lighted place that attracts greater numbers of mainstream merchants and shoppers, she has riled existing customers who don’t want more rules—or more rivals. These moves also pit eBay much more directly against bigger and more consumer-savvy behemoths. AOL Time Warner, Microsoft, Amazon, and Yahoo! are all trying to create online malls where people can buy just about anything from anyone.

Stringent rules
But as eBay grew from a small town into a city, urban problems erupted, such as contraband goods. Since early 1998, eBay has used more stringent rules to crack down on crime, and banned sales of firearms. Indeed, eBay has increasingly realized that, like government in a democracy, it can’t leave absolutely everything to the people.

eBay’s key public-works project: its computer network. Until last year, it was plagued with outages—including one in June, 1999, when eBay was completely shut down for 22 hours thanks to software problems and no backup systems. Former Gateway CIO Maynard Webb, who joined as president of eBay’s technology unit, has upgraded systems so eBay’s site is down less than 42 minutes a month despite much higher traffic. Credit that partly to Whitman, who dived into the technology despite her lack of experience in it. Still, eBay’s customers had a big part, too. Shortly after Webb joined, he recalls, eBay’s discussion boards twice lit up with user complaints about site glitches. His techies claimed nothing was amiss—and both times were proved wrong.

As befits a corporate democracy, eBay’s biggest challenges are political. Features good for buyers, such as those e-mail auction referrals, can hurt sellers. Lately, sellers are especially peeved at eBay’s promotion of large commercial companies such as Disney, which rates a special area in the Disneyana category. The general consensus of veteran sellers is that they’ve forsaken the people who built them in favor of corporate sellers. eBay argues that commercial sellers lend credibility to their categories, drawing more buyers to all the sellers—a point many merchants concede.

Yet there are those who think eBay isn’t listening as well as it once did to its core individual and small-business merchants. "They’ve gotten too big for their britches," fumes Ron Saxton, a seller of die-cast cars. eBay didn’t consult its customers when it launched its Auction for America campaign a week after the September 11 attacks, aiming to raise $100 million in 100 days for victims. And eBay’s insistence that sellers use its billing system, rather than let them accept checks or use a more popular rival system called PayPal, rubbed many the wrong way. That may partly explain why the charity drive has raised less than $6 million halfway through—despite donations such as Jay Leno’s celebrity-signed Harley-Davidson motorcycle, which sold for $360,200.

It’s no surprise, then, that as eBay grew beyond its ability to address individual user concerns, Whitman has pushed it to devise a constant stream of new ways to tap the expertise of its customers en masse. Naturally, eBay harnesses the special qualities of the Internet to gather intelligence much deeper than most brick-and-mortar businesses can obtain. For instance, before eBay revamped its bread-and-butter collectibles categories earlier this year to make products easier to find, it first e-mailed 1.2 million customers asking them to check out the proposed structure. Of the 10,000 who responded, 95% of them had suggestions, and many were used.

New territory
Most intriguing, customers have been pushing eBay to move its e-commerce system outside the borders of its own Web site. Ritz Interactive, the online unit of Ritz Camera, for instance, is using the technology to run eBay auctions on its own site. Says Ritz CEO Fred Lerner: "eBay has very aggressive plans to create an e-commerce platform." Indeed, eBay is encouraging others to build software applications based on eBay technology—much as Microsoft does with its Windows OS. A flourishing ecosystem of companies could enrich eBay’s marketplace by providing support services such as listing tools, escrow, and bill payment. Essentially, says a SG Cowen Securities analyst, eBay aims to become the operating system for e-commerce.

It’s exciting new territory—and dangerous, too. For starters, a raft of rivals from Yahoo and AOL to Microsoft and Amazon aim to be the biggest places for e-commerce, too, and some are making fast progress. But there’s a bigger question: Can eBay’s values survive such grand ambitions? After all, trying to be the Microsoft of e-commerce doesn’t sound, well, very eBaysian—which may be why Whitman frowns and demurs when people describe eBay’s goal in such stark terms.

For his part, eBay founder Omidyar frets that the growing participation of large commercial sellers could dilute eBay’s unique culture. "If we lose that, we’ve pretty much lost everything," he says. eBay’s people power made building a business a breeze compared with everything conventional companies must do. Keeping in touch with all those millions of customers from here on out won’t be so easy.

By Robert D Hof in BusinessWeek. Copyright 2002 by The McGraw-Hill Companies, Inc