November 13, 2000 12:00 PM PST

Webvan defends business model despite woes

Webvan's showdown with skeptics is taking place in San Francisco, the de facto proving ground for the online grocer's business model.

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Webvan woes
The Internet's biggest supermarket pledged a year ago to be breaking even financially at its San Francisco Bay Area operations, its first and most important marketplace. But Webvan's story is still being scribbled in red ink.

"If you can't create demand in the world's most heavily wired city, it doesn't necessarily bode well for less technologically advanced markets," Gomez senior analyst Matt Stamski said about Webvan's future prospects.

Webvan, which is operating in 10 U.S. markets, is engaged in a critical campaign to reach profitability and increase demand. As part of that effort, Foster City, Calif.-based Webvan last week hiked delivery fees on some orders and unveiled a redesigned Web site and logo.

Webvan's broken promise to break even in the Bay Area by its fifth quarter of operation--this September--did not go unnoticed by Wall Street. A score of analysts downgraded the company's stock, and the market sent the share price tumbling to below a dollar. It was trading at $1.09 early Monday.

Prudential Securities' Mark Rowan, who dropped Webvan from a "hold" to a rarely seen "sell" rating, chided the company for not controlling its administrative costs. Webvan had revenue of $87 million for the quarter, but the costs of paying salaries and the like grew to a whopping $115 million.

At the same time, the company projects that at its current burn rate, it will run out of cash next summer. Unless Webvan can turn one of its operations into a money maker, executives will face the daunting task of persuading investors to back a 2-year-old, unprofitable company that has already spent almost $800 million.

But Webvan is undaunted: "We will be profitable in all of our 10 markets by the end of next year," Webvan spokesman Bud Grebey said last week.

Investors today are generally fleeing the e-commerce sector. Like an exclusive New York nightclub, the markets have hung a velvet rope at the entrance to bar the out-of-vogue dot-coms.

Just last week, former Internet stars such as Furniture.com, Pets.com and MotherNature.com called it quits. All three companies spent millions growing their businesses, but when the money dried up, they were unable to find new investors.

Making ends meet
Webvan was among a group of start-ups, such as Amazon.com, Kozmo.com and Toysrus.com, which had business models--with Wall Street's blessing--that required large capital investments.

Each of Webvan's see A News.com webcast: Dot-coms: Down and out?four state-of-the art distribution centers cost about $35 million. The 330,000-square-foot, fully automated centers are beneficial because they require far less manpower to operate and hold much more inventory than several supermarkets. But their large up-front costs are scary to investors.

Webvan has the now dubious distinction of raising more money than any other e-tailer. The company attracted more than $400 million in private investments and raised $375 million in its IPO last November.

Webvan has a $1 billion contract with engineering company Bechtel to build the company's distribution centers. But the Oakland, Calif., warehouse, built in June 1999, is operating at only about 30 percent of capacity, a figure noted by Rowan when he downgraded the stock.

"We feel this clearly points to a demand problem in the most connected city in the world," Rowan said in his report.

The warehouses hold enough capacity to fill 8,000 orders a day, a mark Webvan had not planned on reaching until its third year of business, Grebey said.

Webvan averages about 2,350 orders a day, and by its own estimates, it needs to reach about 3,300 to become profitable--a gap of some 40 percent.

"They built the sophisticated systems without the requisite demand," Stamski said. "Can they change consumer behavior is the real question."

Said Grebey: "We have our goal set. We know what we have to do, we are confident with our metrics, we are comfortable saying that by the end of next year we will be profitable in our 10 markets."

Feeding demand
Webvan has strived to be a quick and convenient way for people to have groceries delivered to their home, but some customers have complained of long waits in receiving orders. Grebey acknowledged that Webvan has at times been understaffed. In addition, popular delivery times fill up quickly.

"The biggest stumbling block for us has been striking a balance between demand and capacity," Grebey said. "We need to make sure that we have the staff to meet the demand. One can't outpace the other."

Still, the company is rallying behind its strengths. Webvan acquired HomeGrocer last summer, its biggest rival, and has few other competitors. And the company has enough cash to last a year--longer than many e-commerce companies.

Moreover, the company has beaten its goal for the cost of the average order. It needed customers to spend an average of $105 on each order, and they are hovering around the $115 mark, Grebey said.

The company has also expanded its offerings, branching into books, CDs and electronics. Webvan is starting to look a lot less like a grocer and more like a general retailer.

"What they've built is too compelling for it to just go away," Stamski said. "By moving into different product categories, they are much more than an online grocer, and that's good because the day of the pure-play Web grocer is over."

 

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