Brick-and-Mortar Stores Are Snapping Up Existing Web Firms to Try to Catch Up to eBay, Amazon; Home Depot is buying a startup that uses algorithms to set Web prices

February 25, 2013, 7:56 p.m. ET

Targeting Tech-Savvy Startups

Brick-and-Mortar Stores Are Snapping Up Existing Web Firms to Try to Catch Up to eBay, Amazon

By SHELLY BANJO

Three months ago, Rodrigo Carvalho and Lukas Bouvrie were working 20-hour days to raise money and attract clients for Black Locus Inc., a 20-person Austin, Texas, startup that uses algorithms to help retailers sell their wares on the Web.

Now, the recent graduates of Carnegie Mellon University’s business school work for the world’s largest home-improvement retailer, Home Depot Inc. HD -2.53%

The company, which is expected to publicly address the acquisition of Black Locus Tuesday, is the latest traditional brick-and-mortar retailer to buy a startup and launch a “technology lab” to try to catch up to online retailers like Amazon.com Inc.AMZN -2.09% and eBay Inc. EBAY -2.56%

Home Depot says the startup, renamed the Home Depot Innovation Lab, will help it compete in an online environment where prices change by the second and are determined by algorithms rather than merchants. The company declined to disclose terms of the purchase.

The move follows Wal-Mart Stores Inc.’sWMT +0.06% 2011 creation of @Walmart Labs, a Silicon Valley tech shop made up of nearly a dozen startup acquisitions, and the recently created Staples Inc. Velocity Lab in Cambridge, Mass., where engineers and data scientists crunch quintillions of bytes of data and dream up new mobile applications meant to help customers navigate stores and websites.

Other companies including Nordstrom Inc. JWN -2.39% and Neiman Marcus Group Inc. are expanding their e-commerce operations by investing in sites that offer limited-time “flash sales.” TJX Cos., TJX -1.45% the parent company of T.J. Maxx and one of the last remaining megaretailers without an e-commerce website, purchased Wyoming-based online retailer Sierra Trading Post Inc. for $200 million last December.

Retailers have cut way back on opening new stores, and in some cases they have been closing locations. That frees up money for technology and other projects that aim to capture consumers’ online spending.

“Gone are the days where we’re building 50 to 200 stores a year,” says Hal Lawton, a senior vice president at Home Depot. “We’re shifting that capital to technology that can help us advance our business at a much faster pace.”

U.S. retailers spent $58.6 billion on technology in 2012, up 9% from the year before, according to Forrester Research. Online sales rose to $225.5 billion in 2012, up 15.8% from 2011, according to the U.S. Commerce Department.

To keep pace with online rivals, traditional retailers may be forced to move quickly and make some risky bets, says Lori Schafer, executive adviser for SAS Inc.’s retail practice.

“There’s no time to wait and see anymore for these retailers,” she says. “They either get on the bus or they may not be around in the next 24 months.”

To keep up, retail executives are cozying up to venture-capital firms and investment bankers that can help identify promising entrepreneurs and tech trends. Retailers likeTarget Corp. TGT -1.12% and Kohl’s Corp. are stationing top executives in tech havens like Silicon Valley and Austin, where they can schmooze with venture capitalists and bankers and attend tech-heavy confabs like Austin’s South by Southwest festival.

“Retailers are still trying to figure out what the heck it all means, but they know their customers are engrossed in digital commerce so they need to be there,” says Tom Furphy, a venture capitalist and former Amazon executive who played tour guide for a handful of executives from supermarkets and consumer-goods companies at a recent Consumer Electronics Show in Las Vegas.

Evidence is mixed on whether these investments are paying off. Best Buy Co.BBY -0.12% launched its venture-capital arm in 2008, but it has yet to see big payoffs from stakes in companies that make items ranging from electric motorcycles to in-home sleep-tracking devices, analysts say.

Asked for a response, a Best Buy spokesman pointed to a statement CEO Hubert Joly made at a recent analysts conference: “You can expect our management team to be very prudent with future investments, to say the least.”

Retailers may be better off paying for a vendor’s services or taking a stake in an early-stage startup rather than buying the firm outright, says Richard Brail, managing director at investment bank Peter J. Solomon Co.

He also warns retailers about so-called “aqui-hires,” in which established companies buy early-stage startup firms to acquire their employee talent and entrepreneurial culture. These deals can backfire if “founders and top talent leave before skills are transferred to the company,” he says.

The co-founders of Kosmix, a startup acquired by Wal-Mart in 2011 that became @WalmartLabs, left about a year after they joined the corporate behemoth, citing personal reasons. But the startup’s technology remains the foundation of @WalmartLabs, a company spokesman says, and the vast majority of the original employees remain among the lab’s workers.

Kosmix co-founder Venky Harinarayan says the founders intentionally created @WalmartLabs as a decentralized organization that could outlast them. “Two-pizza teams,” groups small enough to be fed by two pies, were put in charge of completing individual projects, such as revamping Wal-Mart’s search engine.

“Instead of managing everything centrally, we gave people ownership and let them run,” Mr. Harinarayan says. “That continues today.”