Commentary: Webvan Left the Basics on the Shelf

I confess, I'm bummed. On July 9, Internet grocer Webvan Group Inc. (WBVN ) called it quits. Sure, it was no great shock: Industry observers had long predicted its demise. Still, as a regular customer since 1999, I don't relish the prospect of once again lugging home diapers and jugs of water from my neighborhood supermarket.

Despite some clear advantages--backing from such savvy financiers as Goldman Sachs and Sequoia Capital, a well-respected management team led until April by former Andersen Consulting chief George Shaheen, and more than $1 billion in cash--Webvan's business model was fundamentally untenable. It simply made little sense to pour huge amounts of capital into the grocery business--which ekes out net margins averaging barely over 1%--without evidence that enough shoppers would change their habits.

STARK CONTRAST. But Webvan built a huge infrastructure that could only work if droves of consumers quickly embraced buying their peaches and plenty more online. That never happened. What's more, Webvan depended too much on technology as the driver of its business while overlooking the basics of the grocery industry. "We made the assumption that capital was endless, and demand was endless," new CEO Robert Swan said in a June interview.

Bad assumptions both. In its short life, Webvan burned through more than $1 billion building automated warehouses and pricey tech gear. Never was the overspending clearer than when Webvan merged with rival last year. Its go-for-broke approach stood in stark contrast to HomeGrocer's slower moving, more conservative strategy.

Webvan shelled out more than $25 million for each of its massive facilities vs. HomeGrocer's $5 million or so for smaller, lower-tech operations. Webvan's warehouses needed some 1,000 servers and 16 employees to run the back end, but HomeGrocer's got by with just 100 servers and two employees, insiders say. And while Webvan needed about 4,000 orders a day to break even per facility, HomeGrocer required just 1,500. "Webvan took an extreme position," says Evie Black Dykema of Forrester Research Inc. "They opted to automate the entire business and that dug a very big hole."

At the same time, many of Webvan's managers were so enamored of the company's original vision that the cost-cutting measures it did finally take were steps that grocery veterans would have known to avoid. For instance, Webvan switched to lower-quality produce suppliers in California, turned off customers. I, for one, stopped ordering cucumbers because they arrived too squishy. "We slipped," conceded CEO Swan. "We had started to think of the customer as a statistic or number instead of as a Tom and a Sally."

So does Webvan's failure mean that online grocers' prospects are no better than that of a carton of milk past the sell-by date? Not necessarily. Some believe it can still be a solid business, though one that will likely mature more slowly than anything Webvan anticipated. A soon-to-be-released study from IBM's consulting arm predicts that by 2004, enough demand will exist in some metropolitan areas to support at least three profitable grocers in those markets. "There is demand, and there are profitable ways of servicing these markets," says IBM's Ming Tsai.

Several old-fashioned grocery chains claim that they are already making money at it. Royal Ahold, the Dutch-based chain that now controls online grocer Peapod Inc., says its Net business is profitable in Chicago and Massachusetts. Safeway Inc. is revamping its online unit,, by employing a profitable business model developed by Tesco PLC, the large British-based grocery chain. The difference? Both companies have eschewed spending on new warehouses and building up separate inventory; instead, they are servicing online orders through established stores. Rather than a brave new market to conquer, they see online shopping simply as one more channel to serve existing customers. For now, that looks like the most likely path to online grocery profitability. In the meantime, it's back to the checkout line for me.

By Linda Himelstein

With Gerry Khermouch in New York

— With assistance by Gerry Khermouch

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