What makes a winning Net grocer?

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Flawed assumptions
In retrospect, what did Webvan do wrong? Robert E. Mittelstaedt Jr., vice dean and director of the Wharton School's Aresty Institute of Executive Education, believes that the company's baseless assumptions led to its blunders. To recount, Webvan assumed:

• That a very large number of people would prefer to buy groceries online and have them delivered at home rather than buying them at a physical supermarket. This belief led them to reckon that Webvan's sales would explode, and that people would place a high value on not having to go to a physical supermarket.

• That so much inefficiency existed in the grocery industry's infrastructure that Webvan would garner a bigger margin if it rebuilt the whole infrastructure--by doing all its own warehousing and logistics and trying to move further up the value chain by cutting out the wholesalers.

• That if a Web site gave shoppers more choice and a wider selection of products, people would be willing to pay at least the same price if not a premium for the privilege of shopping online as they did in a physical store.

As time was to show, each of these assumptions was wrong. According to Mittelstaedt, Webvan's biggest mistake was assuming that people did not want to shop in a supermarket. "It turns out that a large number of shoppers haven't made their purchase decisions before going to the store," Mittelstaedt says. "This is where Webvan ignored the basic laws of economics: You can't get people to buy something they don't need. When it comes to groceries, you can't get a person to buy a delivery service that is convenient for them if they have not decided what to order."

Had Webvan made its groceries dramatically cheaper--selling them, say, at half-price--then conceivably some people would have thought more about their needs and organized their shopping behavior to make the process work. But if the groceries "are the same price online as they are in the stores, it doesn't have the same incentives except for a very small percentage of the population that finds buying online more convenient," Mittelstaedt notes.

Webvan's second mistake was to try and reinvent the whole infrastructure that the grocery industry has evolved over the last 100 years. It turns out that the infrastructure may be more efficient than people realize. "Webvan spent huge amounts trying to integrate this infrastructure, and it also didn't do it as efficiently as it thought it would," Mittelstaedt says. "It would have taken 10 years for Webvan to learn how to integrate its infrastructure, and it ran out of capital long before that."

Webvan's third mistake was to choose San Francisco as its starting point. "The company assumed that that market had people with high incomes, higher interest in quality of food, and they thought that this would be a good place to start, but that market is very difficult from a traffic standpoint," Mittelstaedt says. "It's got hills, houses that are hard to reach, and it's a mess from the standpoint of having to deliver things. You have to drive a lot to get to where you want to go, and it's a traffic nightmare. That added to Webvan's implementation problems."

Mittelstaedt points out that if all these errors are added together, the result is that Webvan invested a billion dollars based on very shaky assumptions that don't hold up under economic scrutiny. An electric company that wanted to invest $1 billion in building a new power station would have to look long and hard at the demand for electricity before making such a decision. A chemical company would have to look thoroughly at the demand for plastics before deciding to build a billion-dollar plastics plant.

Webvan, however, did not go through that exercise. So rosy was the view inside the dot-com bubble that it did not need to--and the company and its investors eventually paid the price for that mind-set.

Tesco: Slow and steady
With $32 billion in annual sales, Tesco bills itself as the "number one food retailer in the U.K. and the largest e-grocer in the world." When it wanted to enter the world of e-business, however, its approach was dramatically different than Webvan's. Tesco executives recently told BusinessWeek that back in 1996, the company tested whether shoppers were willing to buy groceries online by introducing a single Web site at one store in Osterley, England. In fact, as BusinessWeek notes, "Tesco's big bet was to bet small."

Early on in its e-business experiment, Tesco realized that it would have to address one key question: Should it supply shoppers with groceries taken off the shelves of its existing stores, or would demand be so high as to require the construction of dedicated warehouses? Tesco decided not to invest in the construction of special warehouses until it had a better sense of online consumer demand. The company kept testing and readjusting its online sales process, letting customers order groceries on the Internet and supplying them from its existing stores, for nearly two years--which was not only an extremely long period in "Internet time," but also coincided with the height of the dot-com boom.

At the time, Tesco was often criticized as a company that did not "get it," and which stood timidly by letting other, so-called "purer" Web-based retailers forge ahead. By plodding along at its tortoise-like pace, however, Tesco learned a lesson that its hare-like rivals did not: that for the time being, online grocery shopping represented a niche trend rather than a full-blown mass market. By 2000, for example, though Tesco.com's annualized online sales were running at a rate of $420 million a year, this was less than 2 percent of the company's total revenue of $32 billion.

Taking the gradual approach helped Tesco.com learn at least two significant lessons. First, rather than promising ambitious home deliveries, the company experimented with having customers order their groceries online, but pick them up at a store. Customers saved on the time and effort it took to pick products off the shelf, and they found a bag of groceries waiting for them when they arrived. At the same time, however, if they wanted to add one or two items to their order, they had the option to do so.

In addition to pre-packaging orders for shoppers, Tesco.com began to deliver groceries to customers' homes near each store. In an important departure from Webvan's strategy, however, the company imposed a delivery charge right from the beginning. Not only did this approach help Tesco.com recover part of its delivery costs, it had another positive result: The company saw the shoppers' order sizes increase as households strove to get maximum mileage for the delivery charge.

This approach kept Tesco.com growing. On Sept. 18, 2001, Terry Leahy, chief executive of Tesco, announced that this year Tesco.com's sales were "up 77 percent on last year, a period when we were still rolling out the service. Grocery home-shopping made good profits; however, overall, Tesco.com made a small loss of 3 million pounds (in the first half), reflecting the launch cost of new sites such as our wine warehouse." He added that Tesco.com "made excellent progress and we now reach 94 percent of the U.K. population. In the first half our grocery home-shopping operation achieved like-for-like sales of nearly 40 percent and created 600 new jobs."

In an effort to extend its model to the United States, Tesco.com last June announced a partnership with Safeway, one of the largest food and drug retailers in the United States. The company, which is slightly bigger than Tesco--its annual revenue is $32 billion--operates more than 1,700 supermarkets in the United States and Canada. Since January 2000, Safeway has been providing online grocery shopping through a Texas-based unit called GroceryWorks. As part of the deal, Tesco.com has bought a 35 percent stake in GroceryWorks for an investment of $22 million in cash as well as intellectual property and technical resources, while Safeway holds 50 percent of GroceryWorks. According to Leahy, the objective was to introduce the Tesco.com model to American grocery shoppers in collaboration with Safeway. "With Tesco's know-how and the Safeway brand we have the perfect combination to bring grocery home-shopping to the world's largest market," Leahy said.

Will Tesco.com's approach work in a market where Webvan failed? According to Mittelstaedt, it well could. "The reason why this works is that Tesco used the technology to make the existing shopping process that people were used to more efficient rather than trying to totally reinvent a process that people were not used to."

Wharton's Wind, too, sees considerable potential in Tesco's approach. Like Mittelstaedt, he says that Tesco "basically has to worry just about distribution from the store to the home. This is a far more economical model--and it offers the opportunity for considerable cross-selling. Tesco has found out that by adopting this model, its online customers have increased their purchases from the stores, and people who used to shop in the stores have increased their shopping on the Web. So there is a crossover effect between the two channels."

Wind explains that this model is also starting to catch on in other parts of the world. Caprabo, a European supermarket chain that is "replicating the Tesco model in Spain, has announced that it expects to break even this year--in less than a year," he says. "The reason is simple: The entire cost of launching Caprabo.com was as much as opening a 20,000-square-foot store. And the volume of sales has been amazing. Within the first three months, even though it was just one store out a network of 52 stores that introduced online sales, that one store already accounts for 6 percent of Caprabo's total sales volume."

Ask Wind why he thinks Webvan flopped so mightily, and he scoffs: "Webvan had the arrogance to think it could conquer the world. Money was cheap, and venture capitalists were willing to fund any dumb idea. But primarily Webvan forgot to look at consumer behavior. And it forgot basic economics."

 
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