Copyright 2000 Paul Farris and the Darden School Do Not Distribute

Copyright 2000 Paul Farris and the Darden School

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Outline, Class 1, The Transformational Effects of E-businessl Web site: http://faculty.darden.virginia.edu/ebiz/l Course objective: overview of e-business and its

transformational impactl On-line “homework”l Pre-class surveysl Discussion procedures:

– Instructor poses question (open or direct to school)– Site coordinator (Graham Mercer or Chris Boerner) (selects

volunteers and monitors contribution– Control returns to instructor

Outline, Class 1, The Transformational Effects of E-business

l Attendance Policy: check the sitel Materials: most can be printed from links at the site; a

few will be distributed in advancel Exam: Open book/open note; short-essay questions,

will refer to the cases, readings, on on-line work.


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Online Grocery: Which Business Model Will Win?

How many were able to read the case: Online Grocery Industry?

l Haas?l Michigan?l Darden?


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Case Discussion Questions l Is online grocery a viable business model?

– Yes - Who needs it & why? – No - What are the barriers to success?

l What are the most important elements of a successful fulfillment system? JIT – Quick Response – Efficient Consumer Response

l Which changes are needed to turn a profit?l What are the fundamental differences?

– Online “pure plays” Peapod, Streamline, Webvan

l Who will win?– Pure plays? Bricks & clicks (Tesco)?– Mfg going direct? Other?

Logistics or Marketing?

l Go the last mile, avoid last mile.......Leverage last milel Focused assortment ….Sam’s Club at your Doorl Expand assortment …..Shopping Mall at your Doorl What is the consumer value? Low price? Better

service?l Costs to develop business? l LTV of a grocery customer?l Segmentation?

– High maintenance vs. low maintenance?– Most expensive customers?


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Online grocery was born out of an increasing need for convenience in consumers’ busy lives...

l The Food Marketing Institute (FMI) estimates that the average household (HH) made two trips to the grocery store a week and spent $86/week on groceries

l The average grocery trip takes 47 minutes, not including time to drive, park and unload groceries

l The biggest motivations to buy groceries online are convenience, simplicity and minimal physical effort

LONG-Term Customer Value Comparison

$40

$30

$20

$10

0-$250 0 $250 $500 $750 $1,000

Customer Lifetime Value

PerOrderContribution

*Drugstore

*Bookstore

*Pure-play Apparel

*DirectMail Apparel

*Cash Rx

*3rd Party Rx

*Off-price Apparel

*Grocery

*Vertically Integrated Specialty

*Dept Store Apparel

Assumes 15% discount rate, 4-year customer life for all but Rxwhich is 7-year customer life.


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Economic Factors of the online grocery business model

l Real estate expenses are reduced

l Inventory management may show efficiencies

l Contributions to cover investment and fixed costs depends on customers, fees, order frequency, order size, product categories, and margins.

Industry Projectionsl Why are specialty stores predicted to have more sales?

Source: Forrester Research

Total Electronic Grocery Spending

$-

$2,000

$4,000

$6,000

$8,000

$10,000

$12,000

1998 1999 2000 2001 2002 2003

Do

llars

(b

illio

ns)

Full-Service

Specialty

Hickory FarmsGodiva

PeapodWebvan


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Three major full-service players

l Peapod.com– Industry pioneer– First mover advantage?– Moving from retail pick and pack format to centralized distribution

centers

l Streamline.com– Perhaps the most customer service oriented grocer– In-home cold storage boxes allow for most flexible delivery– Have already incorporated services like dry cleaning pick-up and

movie drop-off

l Webvan.com– The industry behemoth– Largest capital investments in technology and infrastructure

Peapod - The Company

l Founded in 1989, headquartered in Skokie, Illinois, completed an IPO in June 1997

l Bill Malloy, former head of AT&T’s wireless division became CEO in September 1999, now resigned due to health-related reasons

“Smart Shopping for Busy People”“Peapod Promise”

Video: Peapod intro (1:39)


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l Started in a traditional retailer model, now using CDCs

l Mid-1999, in 8 metro markets, 6.6 million HHs (7% of U.S. HHs)

Market Operations Format Chicago CDC (70,000 sq.ft) San Francisco/San Jose

CDC (50,000 sq.ft)

Columbus 2 Kroger stores Boston 4 Stop-n-Shop and a small CDC (20,000 sq.ft.) Houston 5 Randall’s/Tom Thumb stores Austin 2 Randall’s/Tom Thumb stores Dallas 5 Randall’s/Tom Thumb stores Long Island Small CDC (20,000 sq.ft.)

Peapod – Distribution Model

Video: Peapod CDC model (0:44)

Peapod – Delivery Fee Structure and Order Statisticsl New CDC model allows customers to choose from three options:

– $0 monthly fee and $9.99 per delivery– $5 monthly fee and $5 per delivery– $19.95 monthly fee and $0 per delivery

l 2-hour delivery window and give 12 hours lead time

l Average order size starts at $85 and increases to $115 (which isapproximately 5X in-store order size)

l New members order 1-2X/month and over long-term order 1X/month. Peapod expects this to increase to 2X/month over long-term


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Peapod – Profitability Comparison of Retail vs. CDCl CDCs carry approximately 12,000 SKUs

l Under old model, Peapod depended upon local stores for product l New model improves gross margins by 308%l Building a new CDC requires a CAPEX of $1.5 million

In-store WarehouseGrocery Sales 115.00$ 115.00$

Consumer Fees 15.75$ 8.85$

Total Revenue 130.75$ 123.85$

COGS 102.95$ 85.85$

Gross Profit 27.80$ 38.00$

Picking, Packing, and Delivery 14.25$ 19.05$

Other* 4.60$ 8.40$

Variable Operating Expenses 18.85$ 27.45$

Fullfillment Center OH 5.85$ 2.65$

City OH 1.80$ 2.60$

Net Contribution 1.30$ 5.30$

l US Bancorp - Piper Jaffray estimates that Peapod will become profitable by 2001

– 1999 EPS forecast is $.99/share– 1999 Revenue forecast is $89.6 million

l In their target markets (with average market size of 500,000 consumers), they need to achieve 2% penetration to be profitable

Video: Peapod Competition (1:19)

Peapod – Outlook and Financial Condition

500,000 x .02 = 10,000 customers

10,000 x 12 = 120,000 orders/yr

8 hrs x 2.5 deliveries = 20/van/day

20 x 200 days = 4,000/van/year


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Who is the worst customer?

Peapod – Marketing Tacticsl Multi-media campaign

– Radio, Newspaper, Direct Mail, Internet, Trade publications, Loc al branding (trucks and uniforms)

l Interactive Marketing Program called Consumer Directions– Two-year test program whereby Peapod tests internet marketing techniques

and provides manufacturers with advertising, couponing, and product research dataØ Manufacturers can assess the effectiveness of their internet

marketing campaigns from consumer information provided to them

Ø Service is less expensive than traditional consumer panel data


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Peapod – Strategies to Create Competitive Advantagel Established agreements with leading internet sites

– Three year exclusive agreement with Excite to be the only food retailer to advertise on their site

– Homehearts.com - media site operated by the Hearst group– Greatfood.com - ordering site for specialty and hard-to-find international items

l Peapod Packages is an attempt to gain national awareness– Customers in existing markets can order dry goods and have them shipped

anywhere in the country– Allows them to increase brand awareness before they expand into new

markets– Offer bundled and themed packages like “Christmas” and “New Baby” that

customers can customize from a pre-defined list of goods– Addresses the need for specialty gifts and bundled meal solutions

Peapod – Customer Online Experiencel Site is a virtual supermarket with electronic aisles l Personal lists for frequently purchased goodsl Personal shopping instructions can be added (i.e., only very ripe

bananas)l Extensive product sorting mechanisms

– Nutritional content (Fat, calories, cholesterol level)– Price– Sale items– Kosher– Brand or category

l Coupons accepted by drivers but can only be applied to next purchasel Online and telephone customer supportl Ongoing order tally

Video: Peapod Customer Online Experience (0:30)


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Streamline – The Companyl Founded in 1993 in Westwood, MA

l 1998 Boston customer base was 2000, expanded to Washington, DC in 1999 and opened a state-of-the-art distribution center in Chicago in 2000 with grocery service to start soon

l As of March 31, 1999, they had 183 full and part-time employees

l Customer service is their focus

l They want to be an aggregator - the source for one stop shopping for all their customers

Video: Streamline Introduction 2 (1:49)

Video: Streamline Introduction 1 (0:35)

Streamline - Operationsl To allow for flexible delivery times, they install a refrigerated box

(refrigerator and freezer) with a keyless entry system in the garage for members and costs members only $30/month

l Have one 100,000 sq. ft. warehouse in Boston that can serve 10,000 customers within a 15-20 mile radius

l Just opened a 94,000 sq. ft. state-of-the-art distribution center in Chicago– 8 different temperature zones to keep every product in its ideal environment– Conveyors move bar-coded totes through inspection and shipping zones – 30% of products are moved by automated carousels that route higher

frequency products to pickersl Use leased refrigerated trucks with Streamline logo

– Vehicles have separate compartments for different types of products– Can accommodate refrigerated, frozen or ambient temperature food and non-

food products, hanging bags and flower boxes

Video: Streamline delivery (0:49)


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l They have the added complexity of “back haul” items– Provide services such as video tape returns, can/bottle redemption, dry

cleaning pick-up, bottled water distribution, film processing and clothing alteration/repair

– This means trucks have to be unloaded and items need to be triaged to correct places

– They do weekly routes as well as scheduled pick-ups in order to accommodate these services

l Use hand held computer device for increased efficiency– Allows them to pack multiple orders at a time– Directs them to pick/pack items in the most efficient manner

l Items are segregated by fast and slow moving items when picking and packing

l Picking and packing occurs overnight

Streamline – Operations (continued)

Streamline – Customer Servicel Use back haul capability to participate in local food and clothing

drives, which allows them to gain awareness through grassroots marketing efforts

l Delivery people are trained customer service reps with decision-making power

l The Streamline box also acts as a communication tool– Box is equipped with a message pad customers can use to send

messages back to headquarters– All customer service reports - positive, negative, and neutral - are

logged in an database and are solved within 24 hours of reporting

l They use website to receive feedback from customers and hear from about 35% of their customers weekly

Video: Streamline Customer Service (0:56)


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Streamline – Online Experiencel The online ordering process takes 20-30 minutes/weekl Approximately 70% order online instead of via fax or phone, however they

are migrating to 100% online ordering

l The average customer places 40 orders/year, average order = $102l Customers can place orders up until 11pm the night before the delivery

l Interactive Marketing is a major focus of the website– When you order a Blockbuster movie, a pop-up message appears asking you

if you would like popcorn with your movie. If you respond yes, it automatically adds it to your shopping cart

l They encourage the use of Personal Lists and Don’t Run Out Lists

Video: Streamline Customer

l For services, they’ve formed strategic alliances with Legal Sea Foods, Blockbuster Video, and Quest Dry Cleaning

l Collaborating with Nordstrom on several marketing opportunities– Goal of these programs will be to reduce customer acquisition costs by

leveraging Nordstrom’s very loyal customer base and strong brand equity in customer service

– Nordstrom has stores in 14 of the top 20 markets and distributes 60,000 catalogues annually

l They partner with several consumer packaged goods companies (CPGs) through their Consumer Learning Center

– They charge a fee for the quarterly data they provide– CPGs include: Gillette, Kraft, P&G, Kimberly-Clark, Warner-Lambert, Ralston

Purina, Sargento, Mott’s, Pillsbury, and Nabisco

Streamline - Strategies to Create Competitive Advantage


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Streamline – Financial Condition and Expansion Planl They have three primary sources of revenue - member subscription fees,

sale of goods and services, and marketing research fees collected from CPGs

l Recent financials:– Stock price at $7.19– Market cap of $132.1 million– EPS of -$.37

l They plan to expand to 2-3 additional facilities in 2000 and 3-5 facilities in 2001

Webvan – The Companyl Founded in 1996

l Located in Foster City, CA with one distribution center in Oakland CA that has capacity to service product volume equivalent to 18 traditional supermarkets

l As of June 1999, they had 414 full-time employees, 259 of which work out of the distribution center

l Completed IPO on November 5, 1999– Offered 25 million shares at $15/share

– Raised $375 million form the IPO

l In September 1999, George Shaheen, former CEO of Andersen Consulting became CEO of Webvan

l Offer 15,000 SKUs to customers including specialty items like live lobsters, premium wines, office products, and cigars


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Webvan - Operationsl Have a “Wal-Mart like” hub-and-spoke delivery system

– Entire process is automated from ordering to inventory management to route management

l Orders are picked and packed at distribution center and loaded into color-coded green-friendly reusable totes according to temperature requirements

– Unlike other warehouses, products move to employees through a system of carousels and conveyors rather than employees moving to productØ A picker never has to move more than 19.5 ft. in any given direc tion

and has access to over 8,000 bins of goods from the pointØ This makes the warehouse very scalable because you can add a

significant number of products before you have to add laborl Orders are taken to local docking stations via temp controlled trucks

– A distribution center can support 10-12 docking stations– Stations are located within a 50 mile radius to the distribution center

Webvan – Operations (continued)l Orders are unloaded and reloaded onto smaller vans (have more

than 60 vans) and delivered to customers– No driver will travel more than 10 miles in any one direction

l They source products direct from wholesalers, distributors, and food and drug manufacturers

– As product volumes increase, they intend to sell direct from manufacturers

– They use local suppliers for product, meats and fish– They have a replenishment system that requires that they meet certain

freshness targets– As of June 30, 1999, they were sourcing products from 10 distributors

and 160 manufacturersl At peak performance, they should be able to 8,000 orders/day or

225,000 items/dayl Annual revenues are expected to be $300 million/facility in

comparison to $12 million for a traditional grocery store


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Webvan – Customer Service

l Drivers are trained customer service personnel– 32 hours classroom training– 24 hours driving training– 16 hours on the job training

l They receive competitive salaries and stock optionsl Drivers are expected to make decisions on behalf of the

customer on the spot– They are equipped with wireless devices in order to communicate

directly with headquarters– To make sure customers are satisfied, they can credit the

customer’s bill, request additional products, or make changes to an order

Webvan – Comparison of Traditional Grocery Store Process to the Webvan Process

l Case of cereal arrives at distribution center

l Cereal taken off rack

l Cereal moved to appropriate location for storage/picking

l Customer places order - cereal picked and placed in tote bag

l Tote bag transferred to loading dockl Tote leaded onto truck and taken to

docking station

l Tote transferred to waiting vansl Customer receives cereal at home

l Case of cereal arrives at warehousel Cereal taken off rackl When store needs cereal, cereal

loaded onto truck for deliveryl Store receives cereall Clerk moves cereal to back of store

for storagel When needed, cereal moved to aislel Old/outdated stock rotated or

removedl Customer selects cereal off aislel Cashier rings up purchase and puts

cereal in bagl Customer drives purchase home and

unload

Traditional Grocery Store Process Webvan Process


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Webvan – Customer Online Experiencel Customers choose from available 30 minute delivery windows

– Customers can specify same day windows provided those windows are available

– Can choose to have delivery up to four days after order is placedl Delivery is free for orders over $50 and $4.95 for orders under $50l Tries to be about more than just selling products

– Place a major emphasis on content– Weekly electronic magazine called “Sensations” which features recipes,

cooking tips, and articles by health and culinary expertsl As they learn more about their customers, they intent to make

shopping a more personalized experiencel Does not accept coupons (20% of all grocery shoppers use

coupons)

Webvan – Strategies to Create Competitive Advantage

l In 1999, entered into $1 billion agreement to construct 26 new distribution centers over next three years

– Bechtel will be responsible for entire physical expansion as they move into new markets

– Front-to-back technology system integrates everything from order taking to route management

– System was built to be totally scalable and replicable anywhere

l Their Oakland facility cost approximately $25 million in comparison to $1.5 million cost of Peapod’s CDCs

l Want to be low price in market - claims that their prices are 5% less than local traditional grocery competition

l Operating margins are expected to be on the order of 12% in comparison to traditional grocery margins of 3-4%

l Have food-preparation capability too - offer fresh, high-end chef-prepared meals like “sea bass with Julienne vegetables” and “Asian style baby back ribs”


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Webvan – Financial Conditionl For the six months ended June 30, 1999:

– Total revenue was $395 million– Net loss was $35.1 million or $.48/share

l Market statistics– Stock price at $10.13 (as of 3/1/2000)– Market cap of $3.259 billion– EPS of -$1.27

Response of Traditional Grocers to the Threat of Online Grocers


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Here are some firsthand reasons why one traditional grocer is choosing to go online...l H-E-B is an extremely successful Texas-based grocery chain with $7

billion in annual salesl Has an established premium brand and market share in Houston, Dallas,

San Antonio, and Austin– Major representation in the Hispanic community– Core urban markets are internet savvy

l Over the next nine months, they’ll be rolling out three new services– Online grocery– Online pharmacy business - they already have their own automated central fill

facility– Web-enabled services like pre-ordering of items that will then be packaged for

you and waiting for you to pick up at the store

Tearaway Tesco, GBR

SOURCE: Tearaway Tesco (The Economist 02/05//00, p.62)

• 300,000 registered customers, more than £2.5m ($4.1.m) sales a week. • Tesco claims to be the biggest web grocer in the world, and it’s profitable.• At present, Tesco accepts online sales at 100 of its stores, but will rise to 300, giving it the ability to serve more than 1m home-shopping customers a week.• Exploiting resources from 650 stores nationwide, instead of building expensive CDCs.• When an order is received from the Tesco Direct website, it is sent to the server computer at the store nearest the customer’s home. The order is first assigned to the delivery van, then sent on to a high-tech software-enabled “picking trolley,” and once the trolley is loaded, it goes to the van.• £5 charge for home delivery, far less than cost of the pickers and drivers.• Average web shopping basket is worth about £100. • Tesco Direct runs on Microsoft BackOffice software and inexpensive Dell servers, neither of which are suited to the heavy traffic created by thousands of customers, so they complain of slow-loading pages and crashes when demand is high.• Without fundamental changes to its business model, Tesco is not scalable.


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Backed by Amazon.com

Leading automated fulfillment

technology

Customer service, delivery anytime

First in business, key investor Royal

AholdKey strengths

90 minutes30 minutes2 hoursDelivery windowYesNoNoYesHome for delivery?

$9.95 for orders under $75

$4.95 for orders under $50

$30 monthly fee for storage box

Varies: Average $8.50Delivery charge

Delivery vanDelivery vanRefrigerated truckDelivery vanMethod of delivery

$160$60Customer acquisition cost

87,000200095,000Number of members

$102$71$102$85-$115Average order size11,00015,00010,00012,000# SKUs offered

$25 MM/warehouse$1.5 MM/warehouseWarehouse cost

CDCLarge CDCCDCSome in-store, some CDCBusiness model

$12/Mar ‘00$15/Nov ‘99$10/June ‘99$16/June ‘97IPO / date$21.2M, 1Q ‘00$16.3M, 1Q ‘00$8.46M, 1Q ‘00$21.5 M, 4Q ‘99Revenues

$725.5 M$2.303 B$75.3 M$55.2 MMarket cap, 5/2/2000

3238Markets served1998199619931989Year Founded

HomeGrocerWebvanStreamlinePeapod

Delivery to workplace

#1 food retailer in UKKey investor SafewayNationwide reachKey strengths

1 hour1-4 daysDelivery windowDelivery to officeYesNoHome for delivery?

No (min. order $25)$5.99 and upDelivery chargeDelivery vanDelivery vanDelivery vanFedExMethod of delivery

Customer acquisition cost

37 companies300,000Number of members

Average order size20,00015,0007,000# SKUs offered

Warehouse cost

In-storeCDC + store(perishables)Non-perishablesBusiness model

10.1825PrivatePrivateStock price 5/2/2000

PrivatePrivateIPO / date

Avg $3.12M per QTR

Avg $49.75M per QTRPrivatePVT, $5M YR ‘98Revenues

$23.1 BPrivatePrivateMarket cap, 5/2/2000

50% UK pop.1NationwideMarkets servedOnline - 199919991995Year Founded

WaitroseTescoGroceryNetGrocer


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Do Not DistributeThat was then, this is now….

l At the end of 1999, some supermarket executives were still scoffing at the notion of people buying groceries online. BarryScher, a spokesman for Landover, MD-based Giant Food Inc., said that the biggest grocery chains wouldn’t be selling groceries online or making home deliveries anytime soon. “Customers like to squeeze the tomatoes,” he said at the time.

l On May 1, 2000, Scher was quoted as saying:“The trends are practically changing overnight. This is a very fast changing technology and there’s no doubt that e-Commerce is going to have a very important position within the current retail food store operations in the U.S.”

– Giant entered the online world in April when its parent company (Royal Ahold, NV) bought 51% of Peapod for $73 million

– Safeway, Inc. announced plans for a $30 million investment in Dallas-based GroceryWorks .com (Texas -based chains are dropping Peapod for GroceryWorks )

– In late April, the privately held Lakeland, FL-based chain Publix said it would offer online grocery shopping next year starting in select Georgia and Florida markets.

Source: Cynthia L. Webb and Wayne Carter, “More grocers check out online,” dbusiness.com, May 1, 2000.

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Copyright 2000 Paul Farris and the Darden School Do Not Distribute