Online Extra: Why Online Grocers Won't All Go Hungry

Pure-play Web shops may not rule this market, but the concept of cyber-shopping for food and such is definitely taking hold

When e-grocer Webvan lost both its high-profile CEO and its Nasdaq listing in the third week of April, the pure-play online-groceries sector appeared to have run out of coupons. Customer-acquisition rates for e-grocers failed to meet expectations, and the companies fell short of achieving a necessary critical mass of buyers to cover their overhead. Analysts clucked, saying that convincing people to buy tomatoes online is a tricky task.

Webvan has lasted the longest as a stand-alone. In October, 2000, Priceline shuttered its WebHouse Club grocery service. A month later, Boston (Mass.) Streamline closed. The next day, New England regional competitor ShopLink checked out of the market. The first e-groceries service, Peapod, escaped bankruptcy in April, 2000, thanks to a $73 million infusion from $60 billion Dutch grocery conglomerate Royal Ahold.

"THEY LOVE IT." But hold the mayo: This sector has life in it yet. While Webvan could still run out of cash in the next few quarters, a host of big, publicly traded grocery chains are now mounting their own e-grocery experiments or helping fallen dot-coms deliver the goods. "It's not a question of if this will happen. It's when," says Vic Orler, partner in the consumer-goods and -services practice at consultancy Accenture. "Talk to people who have used any of the services. They love it. A lifestyle once expanded is not easily contracted."

Webvan is counting on customers such as Amrita Singhal, 35, of Berkeley, Calif., to save the day. "As the mother of two young kids, I have been relying on Webvan for over two years. For us, it is the No. 1 service to come out of the Internet," she says. Singhal is far from alone. A two-year study of 412 shoppers completed last year by the University of Illinois reported that 43% of those who tried a Midwest online grocer kept using the service. Of those who continued, 62% said they now buy the majority of their groceries online instead of at the physical store.

That's why Forrester Research predicts that despite its slow start, the market for online grocery delivery will grow to $7.2 billion in 2005, from $600 million in 2000 -- growth that will largely come from bricks-and-mortar players.

PLENTY OF VENTURES. Every major U.S. grocery chain now is testing online shopping in at least one market or planning to launch a service by the end of the year. Royal Ahold has a 58% stake in Peapod, which offers co-branded service in Chicago, Boston, Connecticut's Fairfield County, Long Island, and Washington, D.C. Albertson's, a Boise (Idaho) chain with $9.5 billion in 2000 sales, has been serving online customers in Seattle since 1999. In April, 2000, Pleasanton (Calif.) Safeway, which had $31.9 billion in sales last year, acquired 50% of GroceryWorks, an Internet grocer currently serving three markets in Texas. Publix, a 649-store Lakeland (Fla.) chain with $14.6 billion in annual sales, plans to launch its own service in Atlanta this summer.

"Online grocery can work in every market. But the model will be different in each market, depending on the peculiarities of that market. What works in New York won't work in Toledo," says Ken Cassar, an analyst with Jupiter Research.

To figure out what works best, the grocery giants are testing several models. Royal Ahold, through Peapod, operates fulfillment centers adjacent to bricks-and-mortar stores in Fairfield County and Long Island. In Boston and Washington, D.C., Royal Ahold runs a freestanding packing warehouse. In Chicago, Peapod's original market and the first where it has achieved profitability, Royal Ahold doesn't own bricks-and-mortar stores, so packaged goods are trucked in to a small distribution center from Cleveland.

LEARNING AND EVOLVING. Peapod negotiates for produce with local markets but is able to leverage Royal Ahold's purchasing power to demand low prices. By tailoring models to the market, the company says it will achieve operating profitability in all of its markets by yearend. "In every new industry, you have to experiment and learn. We took the lessons we learned over the last 10 years and evolved. Many of our competitors had very grandiose ideas that one size could fit all. But they didn't have the experience to prove it," says Peapod CEO Mark van Gelder.

Other chains have opted to try in-store packing. When an online order is received, the items are picked off the shelves of an existing store near the customer's house, packed, and sent out for delivery. Though the risk is that certain items will be out of stock, some stores are finding this system more economical than maintaining separate fulfillment centers.

Albertson's, for example, decided this winter that it would pull stock from five existing bricks-and-mortar stores in the Seattle area and close the warehouses it had built alongside them. The large fulfillment centers were stealing space from the traditional stores, limiting shoppers' selection. In-store packing gives online and real-world consumers more choice by making a full range of products available to traditional and online shoppers. Since switching models, general-merchandise selections have increased by 59% and bakery choices by 38%.

"OLD-WORLD THINKING." Other companies are experimenting with models that allow customers to order on the Web and pick up at the store. Foodland, a 27-store supermarket chain in Hawaii with over $500 million in sales, lets shoppers pick up their online orders at a drive-through window. That's only one step beyond faxed-in orders, but the automation alone could save significant costs. To boot, this method keeps shoppers coming to the stores, giving the grocers an opportunity to extend special offers to enhance customer loyalty.

Still, the future of the industry may look more like 7-Eleven than Safeway. Accenture's Orler says a vertically integrated model where grocers do everything from procuring supplies to delivering the goods is "old-world thinking." Instead, he advocates a network model, where retailers manage the relationship with the consumer; warehouse companies offer pick-and-pack services, just as they do for convenience stores; and distribution companies such as FedEx and UPS provide transportation. FedEx's home-delivery effort, which should reach 80% of U.S. residences by late 2001, could work as a vehicle for these services. "The economics of this depend on each partner leveraging their expertise," Orler says.

Surely, such an integrated model is a long way off. And the Webvans of the world have proven that consumer behavior doesn't change as quickly as Wall Street analysts demand. But big bricks-and-mortar players have a much stronger hand to start with. They don't need to acquire customers, build relationships with wholesalers, or buy fleets of trucks. They have well-oiled marketing machines already in place and the luxury of buying up the assets and customer lists of failed dot-com grocers at pennies on the dollar.

Plus, they have plenty of access to capital markets. Combine those ingredients, and you have a recipe for slow but steady growth in online food sales.

By Jane Black

Edited by Alex Salkever

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