Webvan Finds that Shopping for Food Online Hasn’t Clicked with Consumers

It seemed like one of those great ideas just waiting for the Internet Age: Take the tedium out of grocery shopping by enabling people to pick products online. Just click your way through the virtual aisles and let someone else pull items off the shelves and truck them to your door.

But nearly all the American companies that have offered online grocery shopping have failed. And now the last big player, Webvan Group Inc., is on the ropes. Its stock is trading around 31 cents a share, down from $14 a year ago. The Foster City, California company has lost nearly $600 million in the past year.

In February the company’s founder, Louis Borders, stepped down from the board, having already relinquished the chairman’s office in October. Late in February, Webvan shut its Dallas, Texas operation to conserve cash, effectively reversing an expansion strategy that had once called for operating in 26 markets within three years. Webvan had already indefinitely postponed plans to expand to northern New Jersey, Baltimore and Washington, D.C.

With the stock price so low, it is virtually impossible to raise money by issuing new shares. The Nasdaq Stock Market says it will de-list Webvan in the next few months if the company can’t meet listing requirements, including a stock price above $1.

Webvan executives nonetheless speak optimistically about the future and insist that with cost-cutting the company should be able to break even in the second half of 2002. But Wall Street analysts are skeptical. “Demand is weaker than expected,” Merrill Lynch analyst Henry Blodget wrote in a late-January review of the company’s appeal to customers. “Part of the promise in owning this stock was that the company would execute on its aggressive expansion plans, and failure to deliver is disappointing.”

Webvan may well be in its death throes. Does this mean online grocery shopping is a business that simply cannot work, ever? Or did Webvan just do it wrong?

“This is one of the biggest pieces of ridiculousness in the history of the world,” says Robert E. Mittelstaedt Jr., vice dean and director of Wharton executive education. “I wish I’d had the guts to short it.”

Other Wharton faculty members who have looked at Webvan agree the company is in peril, though some think there’s some hope – if not for Webvan then for a successor with a more efficient online grocery model.

Webvan began operations in 1999 and went public that November. On its opening day, shares zoomed to $34 from the offering price of $15. Webvan raised an astonishing $1.2 billion in start-up capital from the offering and other sources such as venture capitalists, putting it in a league with Amazon.com.

At first glance, the grocery business is an enormous market that would seem to have plenty of room for an online player. The average household spends nearly $5,000 a year on groceries and sends someone to the store 2.4 times a week. Compared to that, online companies selling CDs and books deal in peanuts.

Webvan’s founders were no slouches, either. Louis Borders was a founder, along with his brother, of the Borders bookstore chain. Webvan’s chief executive is George Shaheen, former head of Andersen Consulting. The company is backed by top-notch partners such as Sequoia Capital, Benchmark Capital, CBS and Goldman, Sachs.

Webvan’s plan was to relieve busy people of the hassle of food shopping, so the emphasis was not so much on price as on convenience. This strategy was the opposite of that tried by Priceline.com, which offered bargains, not convenience. Priceline shoppers bid for groceries online, but had to go to the stores to pull items from shelves themselves. However, Priceline was unable to offer deep enough discounts to justify the time customers had to spend bidding and shopping, and the money-losing service was terminated last year.

Webvan hoped to minimize costs by setting up a string of futuristic, $35 million warehouses with motorized carousels and robotic product-pulling machines. This was to help offset the enormous cost of its delivery fleets. From its start in the San Francisco area it expanded rapidly to include operations in Atlanta; Chicago; Los Angeles; Orange County, Calif.; Portland, Or; Sacramento; San Diego and Seattle, as well as the now-closed Dallas operation. Last year it bought out its chief rival, Seattle-based HomeGrocer, for $430 million. (Ironically, some observers think HomeGrocer had better prospects, since it relied on simpler, cheaper warehouses.)

Despite the grandiose plans, many observers question whether Webvan really fills a need – whether it really can streamline customers’ routines.

Webvan, says Peter S. Fader, a Wharton marketing professor, solves a “non-problem that doesn’t need a solution….Grocery shopping is not something that people complain about.”

Even though Webvan guarantees deliveries in an unusually narrow window of just an hour, a delivery doesn’t come on the same day the order is placed, and the customer has to be available to take delivery.

One can imagine home delivery saving customers’ time even with these limitations. But in real life, most shoppers are not organized enough to order at once all the items they need, says Mittelstaedt. Few people are willing to pay extra for home delivery if they will have to go to the store sometime anyway, he said.

Wharton marketing professor Stephen J. Hoch says Webvan’s strategy may have involved a degree of projection – its wealthy, time-stressed executives assuming ordinary customers share their negative views of grocery shopping. In fact, many people find this task pleasant, or at least not so terrible. While most people prepare lists before leaving home, lots of decisions about the week’s purchases are made at the store, based on inspiration of the moment. The online experience doesn’t germinate dinner ideas the way scanning the meat counter does.

Moreover, grocery shopping is one of the most efficient forms of shopping Americans do. It’s easy to look along a shelf for the brand offering the best price. “Browsing in this kind of a world is much more efficient than even in a bookstore,” Hoch said.

The supermarket is also a relatively efficient operation for the retailer, since it is, in fact, a kind of warehouse itself. So in creating centralized warehouses Webvan does not make the operation much more efficient than that of its traditional competitors, certainly not enough to outweigh its added cost of home delivery.

The promise of greater efficiency “has just blatantly turned out not to be true,” Hoch said. “The bottom line is that when it comes to having groceries delivered to your door, it’s going to cost more money than going and getting them yourself.” If the added cost is 10%, either in a delivery fee or a premium on grocery prices, delivery could cost the average household $500 a year. “At the end of the day I think there was a small group of people that this service was amenable to,” Hoch said.

Profit margins on groceries are notoriously thin, so it’s hard for Webvan to cut costs enough to pay for its warehouses and delivery operation and still make a profit. Mittelstaedt said the typical Webvan truck does 2.2 to 2.4 deliveries per hour, with an average order size around $70. To pay for themselves, the trucks have to make more deliveries, which means having customers who live close to one another and who place large profitable orders. But Webvan reports its average customer uses the service less than twice every three months, and about half the people who try the service don’t use it again. An operation like this won’t pay the high cost of truck and driver.

To maximize per-truck revenue, Webvan wants to use its fleets to deliver non-grocery items. But Mittelstaedt thinks the company has little chance of competing with Fed Ex and UPS.

Webvan’s warehouses are not operating efficiently, either. The company’s oldest operation, in Oakland, recently averaged 2,160 orders a day, the company reported, while the operation needs about 3,000 orders to break even. This means the automated warehouse is running far below its 8,000-order capacity.

Still, it’s not a given that Webvan will fail, says Wharton management professor Daniel M.G. Raff. “My gut instinct is that eventually the demand will be there. What’s happening to them at the moment is that they’ve made the investment probably more ambitiously than they should have.”

A couple of similar businesses have succeeded in the United Kingdom, he adds. “The busy professionals I know in London all use a service like this.”

But London, he notes, has few large American-style supermarkets. Food shopping there can involve going to several stores and dealing with horrendous traffic and parking problems – all quite different from the suburban American experience. Hence, the most promising markets for online groceries in the U.S may be congested cities like San Francisco and New York, Raff points out.

Webvan had about $212 million in cash at the start of the year, enough to keep operating for two more quarters. After that, its chances of survival are uncertain at best, though some company may someday make online grocery shopping work in the U.S. “If they collapse I don’t think it’s the epitaph for the model for this business,” says Raff.

Webvan, adds Fader, “is a business that’s just way ahead of its time. The technology is not there for it.” Someday, he says, an online supermarket may succeed – probably when virtual reality makes the online shopping closer to the real kind.

Webvan, however, will probably run out of money long before that day comes.

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