Shoe In

(Business 2.0 Magazine) -- After San Francisco Web designer Jon Adams searched unsuccessfully for a pair of dress shoes and some sneakers, a friend recommended shopping online at Zappos.com.

Adams ordered two pairs of shoes from the site. When one didn't fit, he exchanged them for another size and style. Then he purchased a third pair.

CEO Tony Hsieh found a comfy niche - and now holds 20% of a $3 billion market.

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"It's super easy to order, and super, super easy to return stuff," says Adams, who spent about $215. "It's just such a hassle to go around to stores."

Not long ago, the idea of selling something as tactile and personal as shoes over the Internet seemed one of those dotcom-fever dreams. After all, you never saw the trendsetters on Sex and the City hunched over their laptops surfing for Manolos.

Today, though, online footwear is a $3 billion business, and Zappos holds a full fifth of the market. With 4 million customers, the Las Vegas company has doubled its sales every year since 1999 and is on track to hit $600 million in revenue this year.

So how did Zappos best such shoe sellers as J.C. Penney, the No. 2 online footwear retailer? With customer-pleasing policies like this: If the shoe fits, wear it. If not, ship it back - at no cost to you - because a huge inventory almost guarantees you'll find something else you like.

Zappos, of course, is not the first dotcom to build a business on the back of free shipping (Amazon (Charts) has done quite nicely, thank you very much), but CEO Tony Hsieh's big idea was to also make the return process a competitive advantage. Customers are given a link to print out a prepaid return shipping label. Eventually, Hsieh says, "we want to be selling everything and anything with overnight shipping."

While customers love the fast turnaround and free returns, the shipping policy will cost Zappos about $100 million in 2006. In fact, only this year did the company turn profitable, earning a few million dollars.

Still, the policy "is a long-term customer-retention strategy," says Patti Freeman Evans, a senior analyst at JupiterResearch. On any given day, 65 percent of Zappos shoppers are repeat customers, according to the company.

The idea of hassle-free online shoe shopping was in Zappos's DNA from its founding in 1999 by Nick Swinmurn, a San Francisco marketer. Zappos (the name is loosely derived from zapatos, the Spanish word for "shoes") brought in Hsieh, then running a venture capital firm called Venture Frogs, as CEO in 2000, and he hired Venture Frogs co-founder Alfred Lin to be the shoe retailer's CFO.

Venture Frogs poured $1 million into Zappos. More recently, Zappos scored two rounds of funding, totaling $35 million, from Sequoia Capital in 2004 and 2005.

Of course, free shipping works only if you have a lot of merchandise to ship. Zappos's Shepherdsville, Ky., warehouse boasts an inventory of almost 3.2 million items, mainly shoes, representing more than 950 brands. Features like 24-hour customer service and a 365-day return policy have further ensured that Zappos shoppers - about 40 percent male, incidentally - walk away happy.

With rivals like Shoebuy.com, the second-largest Internet-only footwear retailer, and the recent launch of Gap's Piperlime online shoe store, Zappos needs to stay on its toes.

But Heather Dougherty, an analyst at Nielsen/NetRatings, says the online shoe industry is growing so fast that there's room for several players: "It's not a zero-sum game."