Dear Investors, Employees, Partners, and Friends of Zappos:

With the WSA shoe show in Las Vegas starting later this week, I thought it would be a good time to send out another company update.

I'm happy to report that we finished 2007 with approximately $840 mm in gross merchandise sales, exceeding our goal of $800 mm! (I say "approximately" because we are still in the process of closing the books for 2007. See the end of this note for more details.)

I'm also happy to report that, once our audit is complete, we are expecting 2007 to be the first year where we make a decent operating profit. (For the previous few years, we had been running the company at close to break-even in order to maximize our growth.)

It looks like 2008 will be the year where we can reach our goal of over $1 billion in gross merchandise sales -- a goal that we first set back in 2003. For those of you who don't know, here are our historical gross merchandise sales numbers:

1999: Almost nothing
2000: $ 1.6 mm
2001: $ 8.6 mm
2002: $ 32 mm
2003: $ 70 mm
2004: $184 mm
2005: $370 mm
2006: $597 mm
2007: $840 mm
2008: Over $1 billion (goal)

I've been sending out a company update about once every 6 months for almost 5 years now. I thought it would be fun to look back and share some excerpts from the very first "Friends of Zappos" update from 2003, when we were well below the $100 mm mark:

• begin clip from 2003 --

If we spend our money carefully and continue to constantly
improve the customer experience, we will reach over $1 billion
in shoe sales a year in the not too distant future. I know $1
billion sounds impossible at first -- but so did our current
sales volume 3 years ago. But the reality is, it's actually not
that crazy a number, and it's a very achievable goal: By 2010,
total footwear sales in the U.S. will be over $50 billion a
year. Online footwear sales will be 10% of that -- $5 billion a
year. If we continue to be the leader in our space because of
our relentless focus on improving the customer experience, then
there is no reason why we won't be doing at least 20% of all
online footwear sales by then.

• end clip from 2003 --

I thought this was interesting because today, various estimates from 3rd party research companies actually estimate our market share of the online footwear market at somewhere between 20% and 30%.

Here's another excerpt:

• begin clip from 2003 --

Although we happen to sell shoes today, we've built and will
continue to build the platform for a great customer experience.
This will allow us to one day expand into other categories
beyond just shoes. But for now, it's important for us to remain
focused on being the leader in online footwear sales, in terms
of both selection and service.

• end clip from 2003 --

Back in 2003, we didn't have a specific time frame for expanding into other product categories. In 2007, we started expanding into even more categories, and by the end of 2008, we expect to be selling all of the following, some of which are already on our site:

• Footwear
• Apparel
• Sunglasses
• Watches
• Bags
• Bedding/Linens
• Cosmetics
• Luggage
• Electronics

In looking back on the past year, here are some of the highlights from 2007:

• In December 2007, we broke $100 mm in gross merchandise sales

(in 1 month) for the first time in the company's history, and
had our first $5 mm day.

• We now have over 7.4 mm paying customers, representing

approximately 2.5% of the US population. Or put another way,
approximately 1 out of every 40 people in the United States is a
customer of ours.

• Of all the Next Day Air packages shipped in the United States by

UPS in 2007, approximately 1 out of every 75 was a Zappos
package.

• We launched Nike on our web site. We're extremely happy with

the new partnership, and look forward to continuing to grow it
over time!

• We purchased 6pm.com, which is positioned as our discount/outlet

web site. Old inventory that is not sold on Zappos.com now
moves to 6pm.com. This allows us to maintain Zappos as our
premium brand: Zappos stands for the very best service and
selection, whereas 6pm stands for low prices and selection.

• We now have over 1500 employees, and plan to grow to close to

2000 by the end of the year. In Las Vegas, we will soon be
expanding into a 3rd building to accomodate our growth. In
Kentucky, we will be expanding our warehouse operations into an
additional 200,000 square feet.

• We launched our Canada site:

• canada.zappos.com

• We are now operating 4 different vertical web sites, each with

its own separate 1-800 number and specialized staff:

• couture.zappos.com
• running.zappos.com
• outdoor.zappos.com
• rideshop.zappos.com

• As we expanded into other product categories, we've added many

great apparel brands, and plan to continue to add many more in
2008.

• We launched our "Powered by Zappos" program for 3 more brands:

• stuartweitzman.com
• tarynrose.com
• reportshoes.com

• We continued and improved our unique training program for new

hires in Las Vegas. All new hires in our Las Vegas office,
regardless of what department they were actually hired for, must
first go through 4 weeks of Customer Loyalty training (answering
phone calls from customers) upon joining the company. It's
extremely expensive for us to do this, but since we want the
Zappos brand to be about the very best customer service, we
believe it's important for everyone hired in our Las Vegas
office to go through the training (even accountants, lawyers,
and software developers).

Looking ahead into 2008, we plan on continuing to grow primarily through repeat customers and word of mouth. We will continue to build our brand and our culture, because in the long run, brand and culture are the same thing. Every great, enduring company has a strong culture, and we hope to one day be one of those companies.

By the way, one of the comments we've gotten from people that visit our offices is that they had no idea prior to visiting what the culture at Zappos was like. So, to help share our culture with the rest of the world, we've recently launched an "Inside Zappos" blog:

http://blogs.zappos.com/

It's meant to be "fun and a little weird" -- one of our core values at Zappos. Hope you enjoy learning more about us!

This has been a long update, so I will end it here. Thanks to all our customers, employees, vendors, partners, and investors for getting us this far... 2008 will be an exciting year, and I'll be writing another update about 6 months from now to update everyone on our progress.

---

Tony Hsieh
CEO - Zappos.com

PS: Our CFO and Finance Team know that most of you don't really care about the technical financial details, but our accountants and auditors would really prefer that we put in the following technical clarifications for those of you who do care, so here it is:

Gross merchandise sales is a non-GAAP metric. We use it to express the total demand across all of our web sites and stores.
This number measures the dollar value of the orders placed in the year before accruing for certain items such as returns, and it ignores certain timing cut-offs that are required by GAAP for revenue recognition purposes. If we were a public company, we would have to reconcile gross merchandise sales to the nearest GAAP metric (net sales), but we are currently a private company so the gross merchandise sales number should be viewed just as an interesting number that we want to share with our friends.

We understand that the mention of the purchase of 6pm.com may mean different things to different readers. Since you are reading so far down into the fine print, we presume that you must really care about the details of the 6pm.com transaction, or you are just really bored. Technically, our purchase of 6pm.com was not an acquisition of a company. It was a purchase of certain assets, mostly intangible assets. For further technical clarification, we purchased a small amount of inventory and a whole bunch of intangible assets including the 6pm.com domain name, certain trademarks, the customer list, and customer order history.

Still reading? Here are some fun disclaimers to read about:

This email contains forward-looking statements that involve risks and uncertainties, as well as assumptions that, if they ever materialize or prove incorrect, could cause our results to differ materially from those expressed or implied by the forward-looking statements and assumptions. These risks and uncertainties include, but are not limited to, the risk of economic slowdown, the risk of over or underbuying, the risk of consumers not shopping online or at our web site at the rate we expected, the risk of supplier shortages, the risk of new or growing competition, the risk of a natural or some other type of disaster affecting our fulfillment operations or web servers, and the risk of the world generally coming to an end. All statements other than statements of historical fact are statements that could be deemed forward-looking statements, including statements of expectation or belief; and any statement of assumptions underlying any of the foregoing. Zappos.com assumes no obligation and does not intend to update these forward-looking statements. Congratulations on making it through all the fine print. You can thank our lawyers for that.

We recently made some changes to some of our policies, and we've gotten a number of questions and comments from our customers about the changes. Some blogs have also discussed the changes, so rather than try to respond to every single blog, I thought it would be easier to explain the changes on the new CEO blog here on Zappos.

The 2 changes that seem to have gotten the most attention are: (1) Removal of our price protection policy. Zappos will no longer price protect competitor web sites. (2) Removal of our advertising and promotion of free overnight shipping. (We are still advertising free shipping, just not free overnight shipping.)

First, I'd like to thank everyone for all the feedback we've received. It's actually through feedback from customers that we have decided to create 2 separate web sites, Zappos.com and 6pm.com. Here is an explanation of the difference between the 2 sites:

Zappos.com is for customers that want the very best customer service and the very best selection, with free shipping both ways, a 365-day return policy, and 24/7 customer service that's above and beyond what you would normally find at any retailer anywhere.

6pm.com is for customers that are looking for a large selection of products at deep discounts. It's not free shipping both ways, and the return policy is only 30 days. By reducing our costs, this means 6pm is able to offer really deep discounts, as much as 75% off. As we continue to add more selection to 6pm, look for even deeper discounts in the future.

We decided to remove our price protection policy from Zappos because we didn't feel it was consistent with our goal of making Zappos customer service-focused as opposed to price-focused. We found that most of the customers that were using our former price protection policy would actually save even more money if we simply started out with more deeply discounted products in the first place. Instead of on Zappos, you'll be able to find those deeply discounted products on 6pm.com.

Regarding our decision to stop advertising and promoting free overnight shipping on Zappos, it's actually simply just that: a decision to stop advertising and promoting it, not a decision to actually stop doing it.

This means that the vast majority of our customers will still get their orders as quickly as they used to (usually overnight). The only difference is that we made the decision to not advertise or promise it, because we found that our customers were happier when they were surprised by the fast shipping. (Of course, if you're reading this, it kind of ruins the surprise. So pretend you never read this.) So, if you order from us and choose the free shipping option, chances are that your order will come just as quickly as they did before!

(As a side note, just like before, occasionally our warehouse may run into hiccups. For example, a storm may prevent some of our employees from coming to work. If you pay for the overnight shipping option, your order will be given priority processing in our warehouse and guaranteed overnight delivery, even during those times when we run into hiccups.)

We've also been asked why we are referring some of our customers to our competitors. This is nothing new. It's actually something that we've been doing for a long time (at least for the past 4 years), if we feel that it is in the best interest of the customer. For example, if we are out of stock of a particular style and a customer only wants that style, all of our reps are instructed to search on competitor web sites to try to find it for the customer. We believe that it's better customer service if we do that, and that doing so is consistent with our customer service philosophy. We're willing to lose a potential sale in order to be true to the Zappos brand.

We've had some customers point out that we would increase our sales if we advertised and marketed free overnight shipping as opposed to surprising customers with it. I think that's probably true, but we decided that we wanted Zappos to be known as a customer service company, not a marketing company.

I hope this helps in explaining the recent changes we've made at Zappos. Thanks everyone who took the time to give us feedback!